The Animation Duopoly is Officially Over (DWA, DIS)

Two years ago, if you were looking to make money in the movie business it looked like the only sure-fire hitmakers were the computer-generated animators.

The brightest beacon by far was Pixar (now owned by Disney), with its steady release of hit after hit after hit ... Toy Story, Monsters, Inc., later the Incredibles and Cars. From very early on it looked like this Steve Jobs company could do no wrong, and that no one else was going to be able to master this business.

Then came Shrek and Shrek 2, one of the highest grossing films of all time, and Jeffrey Katzenberg's Dreamworks Animation (DWA) became a worthy competitor in the computer animation space ... and to take advantage of that success, they spun off the company from Daddy Dreamworks and had a very successful IPO -- at least for a little while. I bought shares of this one (I've since sold them at a loss), as it looked to me like Pixar and Dreamworks were the only two companies that had the creative juice to build the next generation of animation hits.

Well, it's certainly starting to look like I was wrong. After a lousy year for DWA and a risky change of ownership for Pixar (will Pixar save Disney, or will Disney bureaucratize Pixar to death?), any remaining claim that these two companies own the space sounds thinner and thinner.

One need look no further than this month's box office for another indication.

What happened this month? Well, the animated penguin musical Happy Feet had a great opening weekend (including at Imax, though that's unfortunately not enough to save that company) ... they even beat out the newest James Bond film.

And the latest release from Dreamworks Animation, Flushed Away, rode a similarly ubiquitous marketing campaign to ... blah. Running on several thousand more screens than Borat, it was clobbered and has so far pulled in less than $50 million. Very disappointing results for a film that cost $150 million to make.

Oh, and here's the important bit: Happy Feet was produced by Warner Brothers.

And this isn't the first time we've seen a big animated film come from outside the supposed Pixar/Dreamworks duopoly -- Fox's Ice Age and Ice Age 2 were both huge hits, with Ice Age 2 the second biggest hit of the animated year so far, second only to Cars and significantly stronger than the best DWA performer of the year, Over the Hedge. And if you believe Boxofficemojo.com, Ice Age cost about half as much to produce as Cars or Flushed Away.

Now, it's possible that this is a fluke -- maybe Warner Brothers and Fox are on to something with the ice-themed films, and once the vein of polar bears, woolly mammoths and penguins is tapped they'll fall back behind the leaders.

Or that a story about sewer-dwelling rats and slugs (Flushed Away) just doesn't have the universal appeal that you might have guessed.

But I think it's more likely that DWA and, to a lesser extent, Pixar are just going to have to share the marketplace. There have been no shortage of poor performing animated films this year, from Flushed Away to Barnyard to Garfield: a Tale of Two Kitties and the Ant Bully (those last two barely beat out Al Gore's An Inconvenient Truth, which must really hurt) -- but it's clearly a mistake to bet that Dreamworks is going to have a hit every time out ... and there's no guarantee that Disney Pixar will continue to be able to outperform the other big studios.

There's money in animation again, but it didn't take long for all the big studios to realize it and start to compete ... which means the risks have gone up considerably in this hit-driven business, where a year's earnings really do ride on one film for a small, focused company like Dreamworks Animation. And if you add in the fact that Dreamworks and Pixar generally produce animated films with higher budgets than the competition, the risk climbs a bit more. (As an example, Ice Age cost about $59 million to make and grossed $176 million; Cars cost $120 million to make and grossed $244 million ... so they made roughly the same amount of money, but the return on investment for Fox was much higher than for Pixar in this case).

Nine of the top ten computer-animation hits of all time are from either Pixar or Dreamworks -- five years from now, I don't imagine you'll be able to say that. I'm glad I no longer own DWA, and I think it's going to take some hard work to keep Pixar at the top of the leader board.

full disclosure: As of this writing I do not own any of the stocks mentioned here.

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Not Entertaining Enough (DWA, MVL, IMAX, LGF)

I sold my small position in Dreamworks Animation (DWA) this morning, offloading the shares at $23.25 for a loss of about 35% (average purchase price was about $35, I unfortunately bought shares over a year ago, before and during the Shrek 2 DVD fiasco.

This represents a significant change of heart from my last note about DWA, back in December -- at that time I thought 2006 would be a buying opportunity as we await 2007's Shrek the Third and Jerry Seinfeld's Bee Story film, then Jack Black's Kung Fu Panda and maybe a Puss-in-Boots movie in 2008.

That's still entirely possible, and several analysts see it that way. But after taking a closer look at my portfolio I've decided that I'm uncomfortable with the size and scope of my basket of entertainment stocks. I also own shares in Imax (IMAX) , Lionsgate (LGF) , and Marvel Entertainment (MVL) and I've decided both that I've got too much hit-reliance and entertainment in my portfolio, and that I prefer the other three over Dreamworks. DWA was also the smallest position in this group, so this move also helps with my effort to consolidate and focus more of my time and energy on my larger holdings.

But the size of the position wasn't enough of a reason to sell it -- each of those three entertainment companies has a more compelling upside, I think, than does Dreamworks, though it's also possible that they are also higher risk.

I'm a little concerned about Imax given their very poor luck at choosing their first two films this year (V for Vendetta and Poseidon were tough on them), but I see potential catalysts in the Superman movie and, more importantly, in their possible acquisition or reinvigoration in partnership with someone. That's a large part of the reason I prefer holding IMAX to DWA -- I'm waiting to see what happens as the company "explores its options" with regard to a possible tighter partnership with a big studio or an outright sale of the operation.

Lionsgate, likewise, had a rough Spring -- its highest profile film was the Starbucks-partnered Akeelah and the Bee, which never was able to capitalize on the feel-good word-of-mouth marketing from Starbucks and break through into the public consciousness. Still, Lionsgate has a few things going for them that Dreamworks does not -- they have a huge film library that makes them a very enticing acquisition target if all else fails; they have several franchises that are very profitable (Saw, Tyler Perry); and they have a corporate commitment to profitability, not hitmaking -- they're willing to make or release anything for film or TV as long as they think they can make it profitable, they don't rely on "winning the weekend" for each of their releases (though their low-cost horror and "urban" films have occasionally done just that). This seems a safer bet, and more compelling opportunities for profit, than a hit-reliant animation studio that has so far had trouble even turning hits into profit (which makes me quite nervous about the impact a serious flop would have on DWA).

And finally Marvel ... as a kid who grew up reading Spiderman and X-Men comics I may be simply letting nostalgia firm up MVL's place in my portfolio -- but I don't think so. What I like about Marvel at this point is just the same thing that some, including Jim Cramer, don't like -- they're adding more risk and greater potential reward to their business plan.

Marvel, like Dreamworks, is hit-driven. It was Avi Arad's work to build Hollywood franchises for X-Men and Spiderman that allowed the company to recover and attain profitability over the past several years, and it will be successful films and similar entertainment properties that drive the bus forward. I very much like that Marvel has chosen to continue with their licensed film production -- which will build on the monster hit X-Men 3 to bring us Spiderman 3 next year, and a Wolverine film probably by 2008 -- but to also build a parallel production capacity to bring more Marvel heroes to the silver screen.

This will mean more risk, as Marvel has entered into a $500 million financing agreement to put these films together starting in 2008, but it will also mean much more reward if they can continue building hits based on more of their characters -- instead of a few percentage points of the gross like they get with their older deals for X-Men and Spidey, they'll be pocketing all the profit after paying off debt and covering Paramount's distribution fees. Of course, that means that if the films flop or fail to pay off the debt nut, they'll be in trouble -- but the company will survive, thanks to what I think is very clever non-recourse financing that puts up only the characters themselves as collateral. A flop of a film will mean, if Marvel can't pay the bank, that they lose the right to make any more movies with that character -- that seems fair to me.

The two things that make me a little nervous about Marvel are their penchant for adding debt right now for no good reason (they're borrowing money to buy back shares, which seems foolish to me -- much less sensible than borrowing money to make movies), and the changing nature of their relationship with Avi Arad. Avi was the one who brought Marvel to Hollywood and made it work, but now he's moved on to create his own independent production company that will subcontract to product Marvel's films. This is fine if it just means he has more time to focus on the films, but I'm not crazy about adding another middle man company that will siphon off a bit more profit from Marvel. Avi has done great things for Marvel, but he's also the one who put together the laughable Nick Fury film with David Hasselhof a number of years ago, so he's not infallible.

So four stocks, among which Marvel is the only one I'm holding at a paper profit right now, and I'm offloading one. It should be an interesting couple of years (or months, even) for some of these companies as hits emerge and recede, takeovers are rumored or offered for Imax and Lionsgate, the DVD format war heats up, and online and cable film offerings become more and more flexible and, hopefully, create new revenue streams for Marvel and Lionsgate.

Dreamworks Animation may well have a very good 2007 at the box office, but I'm not convinced that they'll profit from it or that they'll be able to stand out in an increasingly competitive animation landscape. I could very well be wrong, but right now I'm more confident in the prospects for my other entertainment holdings.

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Movie Investing Blahs (IMAX, LGF, MVL, DWA)

The movie industry investments in my portfolio have been a bit disappointing of late ... weak box office and dragging financial results from Lionsgate and Imax are causing a small sector of red in my portfolio.

I'm standing by these companies at the moment, but they're not making me stand up and cheer just yet.

I was clearly a little too optimistic about Lionsgate Entertainment (LGF) and their push to copromote Akeelah and the Bee with Starbucks. It looks like even the might of Starbucks couldn't pull this one anywhere near the top of the box office standings, and I can vouch for the fact that they definitely tried -- every Starbucks I've seen in the last month from DC to California has been plastered with spelling bee paraphernalia and Akeelah soundtrack CDs.

It' s still possible that this will build into a word-of-mouth hit as it hits more theaters around the country, but with the marketing push from Starbucks I definitely expected a bigger splash ... and with the notorious impaticience of theater owners I don't imagine Akeelah will keep its theater slots for long if performance doesn't turn around quick.

Now that's definitely not going to sink Lionsgate -- they can have a few stinkers every year and still do well, and I think Saw III and the next Tyler Perry movie will be successful, along with some films that will come out of the woodwork to make money. Lionsgate isn't built on megablockbusters, as I've written before, and in the long run I think this dip on weak Akeelah news might be another buying opportunity.

But it certainly isn't good news if Akeelah really stinks up the joint -- not for Lionsgate, and perhaps even more so not for the Starbucks entertainment division, which is trying to convince Hollywood that they can help build a hit. I'm guessing nobody in Tinseltown is that impressed yet, though that probably won't turn them off their double-skinny-soy-vanilla-mocha-half-caff-lattes.

Imax (IMAX) is another story ... and another one that's a little disappointing. The large format film company has been slowly trending down since they got a pop from announcing that they were looking for partners or buyers to help ramp up growth.

No news on those partners yet, though several folks are reporting that they've got some preliminary offers and are working with some of the more promising ones ... no real timeline I've seen yet.

Performance was a little weak for the first big Hollywood release on Imax this year -- V for Vendetta, which I don't think anyone liked much in the regular theaters, either. Hopefully Poseidon will be a bigger hit next week, but it's a guessing game which of the popcorn movies Imax partners with will actually achieve blockbuster results. Their non-Hollywood film, Deep Sea 3D, apparently did very well, so the core Imax business appears fine.

The Fool had a nice article out on the potential for Imax in moving to digital, so it's nice to see that they're not being left behind on that trend ... and might even make up some ground, since they believe their operators can make a digital transition pay off much faster than conventional theaters can. They also have a good backlog of installations, including many that are underway now and should hit the earnings book soon.

In the short run, though, until we hear about what the company's going to do -- sell themselves, get a well-heeled partner, etc. -- the stock is more likely to trend down than up. I expect they're probably anxious to get some answers, so I think we're likely to hear something in the next month or two and am willing to be patient. But until that happens, Imax is probably just going to drift, regardless of earnings and movie performance ... even Superman, who will be hitting Imax this summer in 3D, may have to wait in line behind the private equity firms and Hollywood titans if he wants to impact IMAX's stock price.

And as for Dreamworks Animation (DWA) and Marvel (MVL), to close out this note on my movie industry investments ... well, in the short term we're going to have to see if people line up for Over the Hedge and XMen 3, respectively, but both of these companies have much stronger film slates in 2007 than 2006 -- so any opening weekend weakness might bring more buying opportunities there, as well.

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Annual Checkup -- DWA

I'm still confident in the long-term future of Dreamworks Animation (DWA), though my average price of $35.49 means my holdings are still significantly underwater. I've written here and there about this company's prospects, and, while I think 2006's film slate is a little light and this year may remain a good buying opportunitiy, it's possible that their two "no-name" films this year will succeed beyond our wildest dreams ... and the return of the Shrek franchise should be a big boost in 2007. The most important recent change was the addition of Lewis Coleman to the management team -- he's reputedly a tough guy and a solid Hollywood manager that should be able to introduce a little of the business discipline that Jeffrey Katzenberg lacks. I like that Katzenberg should be able to focus more on the creative, and that there will be someone in the management suite who understands both the Street and the studios.

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Not so Entertaining (LGF, IMAX)

Some of the entertainment stocks in my portfolio have been taking a real pounding lately.

Some of my old standbys are just standing around ... Marvel (MVL -- free real time quote from ADVFN) has been flying under the radar with no recent film news, and I think they'll be stable until news comes out about next year's films (though I also think this is a buying opportunity as we wait for Spiderman III and Xmen III). Dreamworks Animation (DWA -- free real time quote from ADVFN)has also been relatively free of news in recent weeks if you ignore what's been happening with their parent studio -- Wallace and Gromit didn't do as well as I would have liked, but Madagascar certainly evolved into a significant film and I'm looking forward to seeing how management handled the DVD market with this one in light of their Shrek 2 mistakes last winter.

But I've noticed some significant weakness in particular in IMAX (IMAX -- free real time quote from ADVFN) and Lionsgate (LGF), and my positions in both are down in the neighborhood of 25% today.

IMAX had a significant downgrade from an analyst who doesn't see mid-size theaters adding their MPX technology to multiplexes -- that may be true, and it sounds like the analyst did a solid channel check, but I don't see why it's a big concern. At this point in their growth cycle with significant overseas expansion and still very few theaters built in the US they don't have to win over the small operators yet. Small theaters follow the trends and have much less flexibility with capital spending than do their large competitors. If they need IMAX to compete in 10 years, perhaps they'll get it. I'm not worried that they don't yet have an interest.

More importantly, IMAX has had a great holiday season with Polar Express and Harry Potter -- more evidence that their strategy of remastering and releasing Hollywood hits and event movies is working great. As they continue to work out the installation backlog and gain new orders, we'll see these films all bringing in additional sales at very little additional cost. I see long term growth ahead (though it's still plenty risky -- the fancier and cheaper home theaters get and the shorter the time lag for DVD releases, the more the "event movie" and the IMAX experience will have to fight for attention). I filled out my IMAX position a number of weeks ago, and now I'm just sitting and watching.

Lionsgate (LGF-- free real time quote from ADVFN) is another matter -- but on the whole I'm optimistic moving forward. They changed their name (from Lion's Gate to Lionsgate -- WOW!), but more importantly the CEO recently spoke about guidance and about the need to refocus on their core competencies.

Their problems this year were the kind of standard Hollywood problems that this small company is not supposed to have -- they aim to buy and create niche film and other entertainment properties on the cheap, promote them effectively but inexpensively, and make money in the corners of the market where the big studios can't or won't succeed (horror, indie films, etc.). This year they had a few films with bigger budgets and significantly larger promotion budgets (Lord of War, Devil's Rejects, In the Mix), and all three of those films flopped at the box office and may or may not even break even on DVD and cable distribution. In light of this, I think management's assertion that they made a mistake in spending so heavily on these films is a good thing -- they recognize a mistake, they plan not to make it again. And even with those higher profile mistakes, the huge successes of Crash, Diary of a Mad Black Woman, and Saw II (a particularly big hit which I wrote about here) helped them have a decent year. We'll see how they do next year, but this is always going to be a volatile one.

I'm not making any decisions based on any of this stock price movement -- I fully expect both IMAX and LGF to continue to make dramatic moves on short term news, including both successful and unsuccessful film releases.

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Dream a little dream of Gromit (DWA)

OK, so now I have a confession to make. I'm a big Wallace and Gromit fan from way back, I love their short films and I even loved Chicken Run and have a fondness for Aardman's other claymation pics as well.

So I might be a bit biased, and I haven't seen the movie yet. But I'm thinking that Dreamworks Animation (DWA -- get free real time quote from ADVFN) might do a bit better with this one than the analysts are predicting -- SG Cowen just came out and said they see no catalysts until Shrek 3 in 2007 so they see the stock standing for a while, but of course no one thought the first Shrek would be such a big hit until it came out, either. That's the beauty of the entertainment industry, sometimes a little pixie dust comes down and shakes the audience up and creates a hit from whence less was expected. I hold a few entertainment companies in my portfolio, and I last wrote about them in detail when I covered Marvel and Dreamworks a few months ago.

Everyone is predicting that Wallace and Gromit: Curse of the Were Rabbit will do OK here in the US, and do quite well overseas for a modest $150 million or so overall take. I'm thinking that Americans might cotton to this duo with far more gusto than is being predicted and vault it into a pre-holiday "hit for the whole family" -- humor, fun for adults and kids, and brilliant craftsmanship that's old-fashioned enough to hold your interest (not just more special effects, yawn), I'd say that's a good list of ingredients for a possible breakthrough.

Now, I might just be blowing smoke because I like this duo, and I haven't yet seen the film -- but it's getting great reviews and I expect the opening weekend to surprise everyone. For those of us invested in Dreamworks Animation who haven't had much to cheer about this summer, we might get to smile a little more in the next few weeks. Track the performance of the film at Box Office Mojo (and by the way, Mojo is pretty good at predicting grosses, but certainly not perfect, and they've got W&G pegged for $15 mil to lead the weekend -- I'll take the over).

Even if this is a pretty big hit as I think it might be, we may see a short-term pop for DWA but it's likely not going to turn things around for DWA in a hurry -- it probably won't become much of a franchise, since part of the magic of these characters is in the painstaking hand animation that has taken Nick Park et al about five years for this one film, and Dreamworks is struggling with some other strategic issues just like all the other entertainment content companies are (Lions Gate and Pixar, to name a couple -- and I do own and like Lions Gate). Beyond that, and perhaps most importantly for the bottom line, Dreamworks Animation is really just distributing this film, they don't own all international rights to the content and the characters the way they do with Shrek and the other films that they've developed themselves so they don't benefit as dramatically as they might for one of their own creations that achieves hit status.

I'm still on the fence about Dreamworks, waiting to see if Katzenberg and his management team can be as effective at managing Wall Street as they are at developing great creative ideas. I expect even the two films next year -- Over the Hedge with Bruce Willis and Gary Shandling, and Flushed Away (also Ardman, but CGI) with Hugh Jackman -- might do quite well and they both have good voice stars and creative new storylines, but there probably won't be much hype in them as they're not part of existing franchises. And there will be lots of competition, too, as Pixar's success combined with the Shrek blockbusters has made almost every studio reconsider big animation projects.

Until the hype of Shrek 3 and Puss in Boots begins pouring on in late 2006 I expect DWA will trade on actual results -- box office, earnings, and, perhaps most importantly given the Shrek 2 fiasco, DVD sales (Madagascar has become a surprisingly big hit -- how about those DVD's this Christmas? Something to watch carefully).

I can live with that, but other than a small possible short-term trade in call options to satisfy my urge to bet on the inventor and his brilliant canine, I'll not be buying or selling anytime soon.

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Marvel Enterprises (MVL) and
Dreamworks Animation (DWA)




Marvel bought January 20, 2005 at $17.31 and
April 28, 2005 at 19.74

Dreamworks bought March 28, 2005 at $38.78 and
May 10, 2005 at $31


This seemed like an interesting pair to write up today, since the Fantastic Four opening weekend was such a nice surprise for many and the evil twin of Marvel lately, Dreamworks Animation, continues to plummet -- first on bad sales projections, then on the SEC investigation and inept guidance. The charts of these two companies appeared to be almost mirror images on Monday of this week (you can see what I mean on a comparison chart from Yahoo here). I'm also invested in a third company in this space, Lions Gate Films, but that one seems quite separate from the first two and is certainly following a different strategy and inhabiting a differerent space on the cultural landscape.

My investment thesis for these two investments is basically this: ownership of great intellectual property in entertainment is a potential cash cow. Both of these companies stand to build great libraries of films and enjoy very high margin licensing deals with the next generation of entertainment products, whether it's video games, toys, television, or otherwise. This industry is inherently high risk, but I don't think it's as risky as the box office watchers would have you believe while they judge both of these companies by the performance of a single character in a single film on a single weekend.

Marvel, as most probably know, is a comic book company that has been through financial chaos and become reborn as an intellectual property and toy vendor that licenses its universe of characters out to films, video games, etc., and also sells comic books.

Dreamworks Animation is the stepchild of Dreamworks SKG, the powerhouse studio put together more than ten years ago with Spielberg, Katzenberg and Geffen and that has done well for itself in film and television. The animation division went public last fall, following the blockbuster Shrek 2 and trying to ride Pixar's stock market coattails, and it has seen some troubled times this year, to say the least. DWA also relies on its own intellectual property, creating films that hopefully inspire kids to bring their parents, buy the licensed toys, and take home the DVD a few months later to watch over and over and over again.

Marvel first.

I haven't seen F4 yet, but I'd like to and it sounds like the fun, squabbling, family angst came through nicely in this iteration of the film, along with lots of explosions and all that other good Summer movie stuff. But I would have been fine with holding this stock long term even if this one film was a disappointment on opening night.

Marvel is a personally interesting stock for me, as well as one that I think is a good long term financial holding. I grew up reading X-Men and Spiderman comics, and I am pleased to see these iconic characters finally being well managed and turned into entertainment franchises in films, DVD, television, toys and video games as well as the traditional comic book publishing that defined the company for much of its life during the past golden ages of comic books.

While I think the comic book as a mass market product will never be what it was in terms of a financial engine for the company or a culturally important media, I do think that the stories told visually in comic books translate very effectively into newer media forms, especially movies and interactive entertainment like video games, and I think Marvel's focus on creating a multimedia universe inhabited by its characters, both large and small, will lead to great success.

Marvel's recovery from the financial maelstrom of Ron Perelman et al is now complete, with a solid balance sheet and cash flow, and an increasingly well-managed revenue stream from licensing deals, publishing (which still makes good money from all the aging fans like me), and movies. The time to buy most recently was probably last summer when the stock remained in the low teens even after the success of Spiderman 2, but I think it's still a good buy at this price -- they had two iffy releases in the cineplexes in the last year in Blade 3 and Elektra, but they still made money on those movies.

Marvel has been very successful in recent years because of their ability to license out proprietary characters to Hollywood and collect a small portion of the proceeds at little or no risk. That makes them a good steady investment even if some of the movies are flops, as long as enough of them still do well enough to keep the movie studios interested in making more. But that's where the story gets interesting.

You see, this model -- which served them well, and gave me some comfort in holding the stock long term -- is being modified in the coming years. Marvel will still license out their characters and stories for films, games and other content, but they're also going to start participating in the riskier end of the business by financing and producing their own films.

As any good investor knows, one generally gets more rewards if you're willing to take on more risk. I think that's the case with Marvel's move into producing their own films, and in this case I think it's coming at the perfect time and their financing deals are structured brilliantly -- as I read the initial releases on this, the company doesn't go bust if they default on their financing deals due to failed films, they just lose the collateral. And the collateral is the characters themselves -- so you could argue that this is still fairly low risk. If Marvel makes a great movie with Captain America using this deal, they collect windfall profits from being the primary producers of the film. If the movie is a stupendous flop and all else is also going poorly for Marvel and they can't pay the bills, they lose the movie rights to Captain America as the collateral they put up for the financing. So in that case, the collateral they're losing -- future Captain America movies -- is already damaged goods, having been proven in the marketplace to be a flop. No great loss.

Of course, that's a simplification of the deal that Marvel has struck with Paramount and their backers who will fund the films, but the point basically stands: Marvel's creations are so valuable, even this second tier of Captain America, Nick Fury, Thor et al., that they are good enough to be their own guarantee of a movie's success. We don't know much in the way of details at the moment about how much the financing will cost Marvel, which is certainly an area for careful attention and concern because the last time MVL was circling the bowl it was due to financial mismanagement and a huge debt burden, but that information should be coming soon and I think Marvel is in a good position to get reasonable terms from its backers going forward.

I also really like this deal because it gives creative control back to Marvel for the next wave of comic characters to enter the multiplex. That is, after all, their specialty, and they have reared these characters and stories from infancy into an entire universe of interacting heroes and villains -- since the early days of Stan Lee, Marvel has always known that it's not about cool suits and crazy superpowers, it's about effective storytelling and great characters. If Marvel can continue developing great stories instead of having to stand by and watch while their characters (a la Elektra) are mangled on film, even if to some profit, I think great films and future success are on the way.

And this way, even if the studios lose interest in superhero or comic book movies, Marvel can make them on their own and show that a good story and a great character can always find an audience. And hey, even if superhero movies go out of vogue for a brief time, there's more to comic books than superheros -- even after allowing for the broad range of stories from Batman (not Marvel) to Fantastic Four to Thor to the X-Men, there's more. Ghost Rider, most definitely not a superhero, will be riding into theaters with Nick Cage soon, and you never know what other great stories lurk in the vaults that spawned Men in Black (a Marvel property, though they acquired it by purchasing a small comic book company).

I am holding on to this one at least until they've released their first film on their own in 2007 (if all goes according to plan). I do have faith in management's performance at MVL, much more so than at Dreamworks, so I will consider adding to my position if one-time events -- like a bad opening weekend -- create buying opportunities.

There are other risks, too, that everyone should be aware of. Management could tire of the turnaround and quit ... people could lose interest in superheroes entirely ... they could have a string of mediocre marquee movies like the Hulk and Daredevil. I personally discount those risks, but they're worth investigating.

And one fear that many people note is that "all the good characters are taken" with Hulk, Spiderman, Fantastic Four and the X-Men all already out there and building libraries of sequels. I disagree -- even if the next wave of characters are less a part of the cultural landsape today than these big three are, success will come to many of them as good stories are told about the most promising of the other 5,000 characters in the library. Not every successful movie has to come with an audience that already knows the characters well from another media -- Shrek shows the lie in that (though it was a somewhat successful children's book, I doubt most most of the moviegoers knew that), as does the original Star Wars, or Raiders of the Lost Ark, Finding Nemo, Men in Black, the Incredibles, Ghostbusters or many other films that came to the screen unknown to their audiences and made the list of the top 100 grossing films of all time (as well as being, many of them, great merchandising successes, which is also key for Marvel).

and as for Dreamworks ...

Most people seem to agree that Dreamworks Animation stock is quite a dissapointment these days. This seems to be a story of merchandising inexperience more than anything else, since their actual films have been, with some missteps, strong successes since the first Shrek debuted a couple of years ago. They have proven that they can create mega-blockbuster films, but they haven't proven that they can effectively manage the DVD supply chain or Wall Street's expectations game.

The expectations management of DWA is something that should be easily fixed -- it is nearly a Wall Street mantra, and it's certainly a cliche, that companies must underpromise and overdeliver. Dreamworks has failed on three fronts lately with this, first predicting blockbuster results for the Shrek 2 DVD that failed to materialize (even though the DVD sales were huge), then predicting a blockbuster in the theaters with Madagascar (which was merely a big success, not a blowout blockbuster in theaters like Shrek 2), and finally revising their earnings downward yet again just a few days ago. Each of these problems would have been improved if conservative guidance had been given, an clearly Dreamworks management needs to learn the difference between creative promotion and hucksterism, which works great for the films, and honest and conservative information sharing, which works great for stocks.

In all fairness, the DVD concern is the same issue that's giving fits to all the movie studios lately. Pixar got a haircut a couple weeks back when they warned that Incredibles DVD's were likely to be returned from stores in greater numbers than expected, the same problem that hit Shrek 2 DVDs over the winter, and everywhere you turn there are articles about the demise of the DVD as Hollywood's cash cow.

I don't believe it. Some bad merchandising and poor demand estimates don't make for a sick industry. Home video and home entertainment are both growth industries -- what else are people going to do with their 85-inch plasma televisions? Watching quality films at home is the preference of most of the American public, and films that are aimed at kids, as all of Dreamworks' and much of Marvel's fare is, are destined to be watched multiple times by young eyes that crave repetition, which means purchases are likely.

The new efficiency in the retail marketplace, where retailers return unsold crates of DVDs if they haven't sold out in their first two weeks, is a wild swing away from past practice. I expect the experts are right on this, that it will depress some DVD sales of blockbusters, but that should be well within the power of DWA (and Pixar, for that matter), to manage. The problem was not that Shrek 2 didn't sell in DVD, the problem was that they shipped more than they could sell, and those returns ate all the

profits they might have otherwise seen from what were extremely strong sales by any other comparison. New techniques, stronger management, and marketing will evolve, and this stock market pummeling should scare DWA into making sure that they really get it right from here forward.

From my perspective, Mr. Katzenberg needs some help on the management front (and they need to stop providing quarterly guidance at all, in my opinion, if they're to be so inept at guessing). I am confident that the big holders of DWA stock, including Paul Allen who would like to sell some of his holdings, will closely watch performance going forward, as will I.

I think the value folks who bought DWA based on their trailing PE of 6 or 7 (now down to 5) are likely to be selling now, even as I'm thinking that Dreamworks goes on sale and might now become more of a long-term value. I look forward to this fall's Wallace and Gromit feature and next year's Over the Hedge and Flushed Away, neither of which comes with much cachet and could provide some upside surprise, but the real blockbusters will follow as the Shrek franchise returns with Shrek 3 and Puss in Boots, and Seinfeld's first animated feature, Bees, comes to the theaters.

My holdings are underwater now on this one, and I'm not planning to buy more this fall as I think it may continue to trend lower without a blockbuster performance from Wallace and Gromit, but I'm going to continue to hold as long as I see signs of management improvement.

What would make me sell?

Continued inept management. I'll give them a year from now, which will include two theatrical releases. If they don't improve by then I'll consider selling -- and by improve I mean manage expectations better, and manage the DVD sales and licensing revenue to increase margins between now and next summer. The films don't have to be blockbusters for me to hold, but their releases and subsequent DVD releases and merchandising have to be successful to the extent that management can control that (with Marvel and DWA both, I consider one or two creative mistakes to be possible buying opportunities. Not so with management mistakes).

There are lots of folks who disagree with me, of course, and they may well be right. The DVD may be dead. Piracy may destroy the intellectual property that is these firms' primary asset. I think both risks are overstated, but that's just me. I expect it's just as likely that I'll be enjoying Spiderman 5 and Shrek 4 in a few years on my new HDTV with the next generation of High Def DVDs.



Technorati tags: Marvel, Dreamworks, DWA, MVL, DVD

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