Hits Keep Coming for Marvel (MVL)

For a company that has had any number of financial issues and shareholder discontent over the years, Marvel (MVL) is certainly banging on all cylinders right now. I can't think of a single company in my portfolio that has seen quite this nice a run of good news of late:

Today, Hasbro has blowout earnings ... thanks in large part to great sales of licensed Spider Man (and other Marvel character) toys. Marvel had a very strange transition of its toy business from Toy Biz back to Marvel, and then from Marvel to Hasbro as the master license holder for Marvel toys. During the transition, sales were somewhat weak and margins dipped and management guided lower ... and some investors were nonplussed because MVL management also noted that this new deal with Hasbro had terms that weren't as good as their previous deal. They explained that the new deal was still positive because of the massively broader distribution that Hasbro could provide, and it's starting to look like that's playing out exactly how Marvel thought it would ... even though it took a couple years of weak toy earnings to get to this point. So the toy business is looking up.

And I wrote a few weeks ago about how encouraged I was about Ghost Rider performing above my expectations -- it's now over $220 million in global box office. That's free money in my calculations, since I didn't expect the flaming skull on a motorcycle to sell that many tickets ... and it's also a great sign that even smaller profile characters can be made into hugely successful films ... even if the critics don't much like the movie. Get ready for Thor, Namor and Ant Man to test this theory in the coming years.

Then a few days ago, word came out that Spider Man was being developed for Broadway by the Lion King people -- crazy, but I don't see any way it could hurt.

And today, news comes out that Spider Man 3, the telling of Peter Parker's dark side, is already selling out theaters on advance tickets two weeks before it even comes out. Advance ticket sales are far outpacing the last episode .... and I have no idea if that has any predictive power, but it can't be bad news. People seem to expect that this will be the biggest movie of the year, which means a little lucre for Marvel and, probably, a big boost in toy sales. The only potential bad news is that this might be Sam Raimi's last Spider Man movie, but I can't imagine Sony and Marvel will let the franchise die ... there are plenty of stories out there to make this a never-ending James Bond-style franchise if they want to do that.

All this on top of another big summer movie from the Fantastic Four puts Marvel in great position to have lots of box office cred going into 2008 when Iron Man (stocked to the gills with oscar nominees) and The Incredible Hulk (Ed Norton? Really? OK) both hit in early Summer and bring all their profits straight to Marvel's bottom line ... the shares aren't cheap, riding as they are on these nonstop waves of good news, but with a whole different long-term calculus for the shares going forward -- assuming that most of the self-produced movies are profitable -- I find the forward PE of 20 or so eminently reasonable. This is a company that I hold for nostalgic reasons as much as financial ones, but my wallet's enjoying it as much as my heart these days.

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If Ghost Rider can be a hit, just wait for Iron Man (MVL)

I was pleasantly surprised to return from a long weekend away to see that Ghost Rider was a huge hit for Marvel and its star, Nick Cage.

I've owned Marvel shares for some time, and even bought a few more recently as it began to become more and more clear that their self-financed movies, beginning with Iron Man in 2008, would be made with great stars and great chances for success.

But to be honest, I expected Ghost Rider to bomb.

Sure, there are fans of every comic book -- and Johnny Blaze's satanic alter ego is no exception -- so a decent outing seemed likely. But flaming skulls don't necessarily conjure up the same fan base as strapping heroes in tights and capes.

And this is the best film opening Nick Cage has ever had -- over $50 million, which is a Prez Day weekend record, and certainly impressive even though Ghost Rider didn't exactly have huge competition (the latest Hugh Grant flick, a Disney coming of age story, and Lionsgate's newest Tyler Perry film were the other big newcomers).

Clearly, the market noticed -- in a time when we're all trying to handicap the value of Marvel's stable of thousands of superheros and comic book characters, and guesstimating whether Marvel can make a profitable movie starring a niche character like Namor the Sub-mariner in a few years, they're offering us some proof: Ghost Rider, far from being a top-ten comic book superhero like Superman, Spiderman, the X-Men, and even probably a step down from the other leading lights like Thor and Iron Man, can still carry a successful movie.

Even if the movie stinks. Oh, yes, that's the other part of the story -- the critics were almost unanimous in throwing rotten tomatoes at the screen, contrary to the huzzahs that they showered upon the latest Batman and Spiderman movies.

So Ghost Rider has a well-respected but not guaranteed blockbuster star in Nicholas Cage (his latest few movies have bombed, including one for portfolio holding Lionsgate).

And it isn't a typical superhero flick, starring as it does a possessed motorcycle stunt rider who turns into an angel of vengeance of sorts, including a nice flaming skull for effect.

And the critics hated it.

But it was still an opening weekend hit. That means Iron Man, Thor, the next Hulk, Ant Man and Captain America have a solid chance to do better, in my book, and that explains Marvel's very nice pop in share price today.

Of course, now the expectations are higher as well, so if Spiderman fails to set box office records this summer, or if Iron Man opens poorly next year, look out below. Hey, even a big dropoff from the opening weekend performance might return the shares to last week's levels, but it's still a nice start.

full disclosure: I own shares in both Lions Gate and Marvel and have no plans to buy or sell them in the near future.

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Super Future for Marvel (MVL)

Sometimes you invest in companies because they're cheap ... and sometimes you invest in companies because, though fairly valued, you think their future is brighter than the market believes.

In the case of Marvel (MVL), I've bought shares for both reasons. I originally picked up shares in the comic book, toy and movie company a couple years ago in the teens, and though it dropped at one point down to $13 or so it was certainly a value proposition when I first got involved.

Now, it's less of a bargain -- but the future is significantly brighter ... and I bought a few more shares this morning at $28.38, upping my average cost per share to the low $20s.

Why now?

I had been hoping for a dip in the price, which hasn't happened (quite the opposite) ... though MVL remains a fairly small position for me even after this purchase, so another buy in the future is certainly possible.

And it would have been more prescient to make this purchase back in the summer when the price was a good 30% lower -- but I didn't.

What has changed since then is that Marvel has moved further past the lump caused by its transition to a new toy licensing deal (they make a lot of their money from licensing characters for toys), and the film slate for the next couple years has been firmed up, with very tantalizing possibilities for both toy and movie revenues going forward.

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The first thing, of course, is the next Spiderman movie -- Spiderman 3, which according to the previews looks pretty dark and impressive, and has the potential to be a mega blockbuster like its predecessors. Of course, this is just a small part of Marvel revenues, since the Spiderman deal was signed when the company was very weak, many years ago, and they only get a relatively small royalty from the movie itself ... though Spiderman toys are always big sellers, and this should help that further.

More important, in my view, is the fact that it looks like Marvel is really going to have a great product on its hands with their first self-produced movie. In 2008, they'll be releasing the first of several films that are produced with their own line of credit, and for which they'll make most of the money (and take on most of the risk -- I wrote extensively about this last February), unlike the relatively risk-free royalty deals they've had in the past for the X-Men, Hulk, Men in Black, Spiderman and other films in recent years.

So a lot of the company's fortunes are riding on making these self-produced films succeed -- and until recently, it was pretty unclear exactly what films would be made, and how promising they would look.

Now, it looks like the first movie, at least, should be a great one -- Marvel has decided to open its film slate with Iron Man, the story of alcoholic military-industrialist gazillionaire Tony Stark, who designs and builds a suit of armor that (eventually) turns him into a superhero. A great character with some depth, and potential for some seriously fun special effects.

But knowing that isn't enough -- in Hollywood it's all about the talent. And that's where Marvel's production head Avi Arad has really done his job.

Starring as Tony Stark will be Academy Award nominee Robert Downey, Jr, who might know something about portraying a wealthy alcoholic.

And as his right hand man Jim Rhodes, Academy Award winner Terrence Howard.

And as his secretary and conscience Virginia Potts, Academy Award winner Gwyneth Paltrow.

Directing will be Jon Favreau, who is certainly competent and well known after hits like Swingers and Elf, though he's much more recognizable as an actor.

That all tells me that Marvel continues to attract top talent (and I, at least, am also looking forward to Nicholas Cage as the Ghost Rider coming soon, though it probably won't move the needle for MVL), and that they are not trying to squeak out bargain basement flicks without stars as has occasionally been done in the past with their characters.

And it tells me that 2008 should be a year when they make a lot of money, since they'll want to front load their self-produced slate to make sure they get the surest hits made first (some of their movies are bound to flop, but as long as they've made money from some hits first they should be in fine shape). Following Iron Man, it'll be a sequel (really a re-start) for the Hulk, since no one was really happy about the first Hulk movie ... and then, hopefully, we're off to the races. Thor, the Avengers, Ant-Man, Captain America, and Nick Fury (already unfortunately immortalized in a terrible film by David Hasselhof a few years ago), and a long list of somewhat second-tier heroes are on the list for consideration for these self-produced films.

As I noted above, Marvel isn't cheap -- but it's a whole different company than the one that existed a couple years ago. No longer a safe bet on a continuing stream of decent royalties built on a stable of popular superheroes, it's now also a big film production house that will make two of its own movies each year and, in many years, rise and fall dramatically on the success or failure of those films. I continue to like their chances.

Disclosure: I own MVL shares as of this writing and do not plan to sell or buy more in the near future.

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Quietly Marvelous (MVL)

Marvel Enterprises (MVL), home of my childhood favorites the X-Men, has quietly had a spectacular month in the stock market, rising from depths of around $17 to today's close well above $23.

This recovery was expected by many folks, though I thought and hoped it would take longer (and I missed the recent opportunity to buy at the bottom).

The past twelve months have been weak ones for Marvel, as they redid their toy licensing program and moved manufacturers, which brought with it some short term costs, and offered up a small movie slate for 2006 as analysts debated their decision to take some additional financial risk by producing their own films starting in 2008. Even the expected blockbuster status of X-Men 3 didn't really move the needle for the company this year.

So we were left to spend the summer pondering just how weak the shares might get during a movie-less fall ... and how strong they might get as soon as investors begin to look forward to 2007, which will include one guaranteed blockbuster (Spiderman 3 in May), one likely one (Fantastic Four: Rise of the Silver Surfer in June), and one possible hit (Nicholas Cage's Ghost Rider in February), and to 2008, which will bring the first of Marvel's self-produced films (Iron Man, scheduled for May). The full projected slate, out a few years, is here.

I've heard investors say that a six-month time horizon is fairly typical of Wall Street investors, and based on that you might imagine that Wall Street is predicting the company to begin performing well right about when Ghost Rider hits the theaters in mid-February, since that's about six months from when this upward move began (or that the Q1 report will be great next year, perhaps because of strong X-Men DVD sales). I was thinking that Ghost Rider was likely to fly under the radar, and that a big move like this was more likely later in the Winter, when Spiderman hype began in earnest.

But a nice earnings release in early August helped to spur interest in the shares again, and more visibility of their new film financing deal certainly helped. Marvel beat some pretty low benchmarks that had been lowered over the winter, and increased their guidance slightly for the year -- due mostly to the fact that they've been borrowing lots of money for a stock buyback (I'm not crazy about that decision, but it's certainly working so far).

And today, Citigroup initiated coverage at a buy on no "new news," and published a $27 price target, which is currently the highest analyst target out there. It sounds to me like the analyst, who specifically noted the likely boost to the share price that Spiderman 3 will bring next May, wanted to be the first one to talk aggressively about this now that the hype is only a few months away.

Marvel is a company that I probably won't ever sell entirely, partly for sentimental reasons, but if the share price returns to the levels we saw in early August, well under my cost basis of about $18, I'll probably try to be a little more aggressive in picking up additional shares.

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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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Hollywood Financing (MVL)

There was an interesting column in the Washington Post today -- Big Deals Are Sequels to Tradition In Hollywood, by Steven Pearlstein -- which made me think a little more about Marvel Entertainment (MVL) and their slate of self-produced movies that are starting to bubble up through the development process.

Marvel recovered from its dark days by rebuilding its licensing on the heels of the success of X-Men and Spiderman movies. But as the recovery settled in, they became very frustrated with the relatively small piece of the action they received on these blockbuster movies, usually single-digit royalties.

And they decided to get into the game. In 2008, they will release their first self-produced and self-financed film, using a credit line that is guaranteed not by the corporate balance sheet but by Marvel's most valuable property: the characters themselves.

According to Avi Arad, who runs the Hollywood business (obsessively, by all accounts) for Marvel, the first Marvel-produced film is expected to be Iron Man, or possibly the Hulk 2 (it's unclear whether the first one out of the gate will be one of the films that uses this new financing line, but my guess is that's pretty likely).

This will coincide with other films by their partners, as they're only exposing something between 10 and 15 of their characters to this self-produced film slate (and to the bank). Sony will release Spiderman III next year, and we'd have to assume that they'll start work on something else in the Spiderman universe immediately following that, given the cash cow that Spidey has become. And Wolverine is expected to get his own film in 2008 or so, again with production by a major studio.

I'm in favor of this new strategy, even though it's certainly risky to get out of the royalty business and start producing your own products -- but after reading this Pearlstein article, I feel even more strongly that this is the way for them to go in (I hope) taking advantage of eager movie industry investors.

Marvel is getting a reasonably good deal on this financing, in my opinion -- they are basically putting up their b-list stars as collateral in order to get the money to make films about them. If the films succeed, great -- they owe only the interest payments on the financing, and distribution payments to Paramount. If the films fail and they can't otherwise repay the loans, they lose only the film rights to those characters -- characters who have already become damaged goods in Hollywood's eyes.

This is a fairly large, corporate version of the things Pearlstein talks about in some detail, taking advantage of folks' interest in investing in movies (and the thirst for new investment vehicles in general), and use that interest to get relatively good terms on something that is, by all accounts, a risky endeavor with a significant chance of failure.

But while I believe that this is a good risk to take, it really rides on the creative direction of the company -- even more than any of their previous endeavors have. If Marvel makes some bad films, all bets are off.

I don't think that is likely to happen -- the most disappointing films from Marvel's recent past, like the Hulk and Elektra, were not subject to Marvel's creative control and didn't tell stories in the Stan Lee way. With a comic book fan and detail oriented guy like Avi Arad running these films, I expect them to be very true to the characters and much more appealing as films, though there are of course no guarantees in this business.

And that's why I still hold my Marvel shares, though I wish I had piled on a little more last fall when we got down to $13 or so and will be looking for more entry points if any disappointment or sell-on-the-news behavior hits the street when X-Men 3 opens next weekend.

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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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Still patiently pleased with Marvel (MVL)

Marvel Entertainment (MVL -- click to register for free RT streaming quote) gave the street a reason to breathe a little sigh of relief with this morning's earnings. They reported more or less what was expected for 2005 results, but boosted their guidance a little bit thanks to their large share repurchase program.

EPS should now come in between 44 and 55 cents, their previous guidance in the last conference call was for 37 to 52 cents.

Now, neither one of those numbers is really impressing anyone -- at $16 you're still looking at an awfully high PE for a company that is expected to have a very weak year.

But the stock is up about 10% as I type this, partly because they raised guidance for this year and largely, I think, because people are now starting to think about 2007. The short term mentality of Wall Street would have allowed us to buy into Marvel's expected blockbuster 2007 at very low prices in 2005 ... no surprise there, of course.

This year, as I wrote in my annual checkup, Marvel's stock may ebb and flow with their licensed feature films, but now the fact that 2007 should be a great year for them is starting to get some attention -- Spiderman 3 will be out that year among other expected solid films, their new toy contract goes into effect, and they'll be providing us by then with some stronger visibility into the casting and stories for their first few self-produced films moving forward through 2008. CNNMoney ran an article on this potential as well recently, which probably reflects this new tide of cautious optimism for Marvel that's playing out in force today.

To be honest, I was hoping that they would continue to downplay 2006 -- which will see an Xmen film and could be much more successful than we're guessing. I would like to own a little more Marvel, and I'll be looking for depressed prices later this year to get a chance to buy in before the good news for 2007 and beyond really gets priced in.

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Annual Checkup -- MVL

Marvel Entertainment (MVL -- click to register for free RT streaming quote) has been extremely quiet since their rough conference call back in November, though it did recover reasonably quickly from their shellacking and return in short order to the current $16 range -- my average cost is about $18, so I'm slightly in the red, but not particularly concerned about it. The only big news since then is a new toy deal -- Marvel is dropping it's own Toy Biz and contracting with Hasbro beginning in 2007 to create licensed toys based on the heroes of the Marvel Universe. It's hard to say what that will mean long term -- Marvel will get a lower royalty rate, but they also reduce their risk with pretty sizeable guaranteed payments, and get the advantage of working with a major toy power who may provide stronger distribution. I'm guessing conservatively that it's probably a wash, with some upside potential. Regardless, 2006 will probably remain a very lean year for Marvel -- during this transition to Hasbro they are downplaying their toy sales forecast for the year, and they are also being quite coy about their expected revenues from the two major films that feature their characters in the next 12 months, Ghost Rider and X-Men 3. As I wrote a few months ago when Marvel hit bottom with their low forecasts for 2006, I'm comfortable holding through this year because I think they're being more conservative than they need to (as a result of having already been burned) and, more importantly, because I like their risky plan to produce their own films starting with the 2008 slate and I want to take part in the potentially higher earnings they'll see from those releases. The shares will probably move this year in sympathy with the performance of their two major films, but I think the real action -- not unlike what I foresee for Dreamworks Animation -- is coming in 2007. I'll wait.

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Clobberin' Time (MVL)

As the Thing, the Fantastic Four's largest and most orange member, says, "It's Clobberin' Time." Marvel Entertainment (MVL) released earnings this morning and the 2006 earnings forecast was shockingly bad, sending the shares down about 20% immediately.

Ouch.

This is obviously a little surprising, but the fact that their earnings for this past quarter were down from the previous year should not have been at all surprising -- no one expected Fantastic Four to have the same impact as the 2005 megahit Spiderman 2, so the fact that their earnings fell year over year was not surprising, nor was it particularly bad in my opinion. Companies that rely on hits are always going to have choppy earnings.

No, what was really bad was that the first impression is that the company basically wrote off next year entirely. They projected earnings of well under half this year's earnings (in a pretty wide range of 37-52 cents/share, following this year's expected $1.02 a share minimum), saying that licensing and toys revenue will likely be difficult next year.

I expect a large part of the reason for that is that we'll be in a long lull between Spiderman movies, and Spiderman is inarguably the king of the licensing roost -- but still, projecting this kind of dismal earnings for a year in which they're releasing two movies that have pretty high expectations (Ghost Rider with Nicholas Cage, and X-Men 3) seems very unsettling.

Peter Cuneo made it clear in this morning's conference call: "our toy forecasts, frankly, are very low for '06"

What else did we learn from the call?

F4 licensing income is going to be worse than originally expected. Other licensing was frontloaded into this year as they extended or renewed more than usual, especially the video game agreement (with Microsoft? They'll release details on that very soon) which brought in $50 million this year in earnings but should bring in actual cash flow annually. That tradeoff between the video game agreement and F4 licensing is why they made their numbers this quarter and will do so this year.

That also means that cash flow is expected to be much better than earnings next year, according to the call -- $70 million, versus a projected $38-53 million in net income.

Marvel has also authorized a big repurchase in common stock, but they're borrowing to do this. That is a significant commitment to the long-term potential and they certainly believe that this will be immediately accretive to EPS, and I tend to agree with that assessment, but it does concern me a little that they're adding debt to do this repurchase given the substantial debt they're already taking on to produce their own films in 2008 and beyond. Definitely something to keep an eye on.

The key reaction I got from the conference call was "very defensive". Defensive about the potential income from next year's movies, extremely defensive about toy and other licensing income. They seem to be incorporating some extremely pessimistic assumptions about consumers going forward, as well as some extremely conservative projections of the popularity of the X-Men 3 and Ghost Rider toys.

Changes are definitely afoot for Marvel, but they're going to take a few years to develop. The toy license is up for renewal at the end of 2006 -- which means that 2007 will bring some significant changes to one third of Marvel's business, and with the 2008 movies having more significant impact on the bottom line their could be some really dramatic changes to the way we think about Marvel in the coming years.

Avi Arad, head of Marvel Studios, was not very specific in the call but did say that current licensed films are moving forward well (including F4-2 and Spiderman 3), and they are going full speed ahead with the slate of self-produced films for 2008 but will wait to see which looks most promising for first release as scripts and talent are identified.

So what do I do with these MVL shares? I still think their self-produced films can be a huge boost to income, and I still think their slate of films over the next two years should drive better toy and licensing revenue than they're expecting. I appreciate that they have lowballed the projections because they want to be very conservative, but I hope they're aiming high while guiding low.

I'm going to hold the shares that are now sitting at a small loss, and if the market accepts their projections about 2006 performance and continues to beat the stock down, I'll have to reassess and see whether I think buying more shares makes sense. I see at least one blockbuster hit in each of the next two years (Xmen 3 and Spiderman 3) which I think will help drive licensing performance higher, and I'm hoping that the toy problems they've had this year can be resolved and the segment performance will improve. The downside seems awfully limited to me, I see no reason to sell.

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Earnings Updates

About half of the companies I own have reported their quarterly earnings, and it is a decidedly mixed bag. I'm going to do a quick summary of how they did, and what I'm thinking about the companies going forward.

So what has happened of significance so far this earnings season?

First, the best ...

Middleby (MIDD) clobbered the baked-in estimates, and showed that CEO Selim Bassoul is still on top of his game at this maker of commercial ovens and cooking equipment. I was lucky enough to buy into this great company earlier this year when it faltered slightly while the founding family was trying to sell out their holdings -- bought some at about $46 and more later on at around $50 over the winter (I found out about this company because it was a Motley Fool Hidden Gems recommendation, one that has since been re-recommended -- that's a great newsletter and I recommend at least giving it a free trial).

Middleby keeps some of the fun in investing by never pre-announcing their earnings release date, so one day the market closes and a lovely surprise bounces up on your browser, as happened last Thursday afternoon. Sales up 15%, international growth still doing great, earnings well above the estimates of the few analysts who follow MIDD ... even with increased debt, which we knew about due to the buyout of the founders shares, and slightly lower margins and higher costs largely due to the acquisition of NuVu and higher steel prices, it's all good news