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Technology > Tech Biz
DreamWorks: Risky business
The IPO was great for the company, but investors may want to stay home and read a book.
November 1, 2004: 5:11 PM EST
By Eric Hellweg, CNN/Money contributing columnist

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BOSTON (CNN/Money) - "You oughta be in pictures!" The come-on works for starlets and silver-screen dreamers, but how about investors?

Investors got a rare chance to buy shares in a Hollywood IPO last week, when DreamWorks Animation went public.

As far as opening weekends go, DreamWorks's debut was a big success -- shares were trading up 40 percent. For early investors and employees, it was the feel-good hit of the fall.

But what about the rest of us? Now that the stock is available, at a forward price/earnings ratio in the mid-30s, what should investors make of this Hollywood powerhouse?

The two rules: Money and hits

First, investors need to remember who makes money in Hollywood. Producers get rich. Movie stars get rich. Even a few directors and screenwriters get rich. Investors? Well, that's why you need to look beyond the Tinsel Town glamour of a property like DreamWorks.

Though the company founded by David Geffen, Jeffrey Katzenberg, and Steven Spielberg makes money in a number of different ways (through DVD releases, merchandise, etc.), the revenue is directly tied to one or two releases each year.

Which leads me to the second rule: Hollywood is a hits business, and you are only as good as your next hit. As DreamWorks has proven in the past, one misstep has immediate and large consequences for the company's outlook. (Think "The Prince of Egypt," "Road to El Dorado," "Sinbad," "Spirit" -- OK, I'll stop. "Father of the Pride" on TV. Stop.)

DreamWorks reported net income of $120.7 million for the first six months of this year, thanks largely to the success of "Shrek 2." But it lost $114.7 million during the first half of 2003, when titles didn't fare as well as hoped.

"This is even more of an issue for DreamWorks Animation than Pixar, as DreamWorks Animation's track record is not nearly as pristine as Pixar's," writes Richard Greenfield, an analyst with Fulcrum Global Partners, in a research note issued after the IPO.

These are not cyclical companies; these are not conglomerates. They succeed or fail based on the tastes of the public, and you can't argue with those tastes. That said, there's a lot to like about DreamWorks, despite its less-than-perfect track record for successful films. "Shrek 2" is the highest-grossing animated film to date, and the company operates with roughly a 37 percent net profit margin. Not too shabby.

The competition

But let's look at DreamWorks's direct competitor. Pixar has had hit after hit after hit, thanks to its leader, John Lasseter, a true storyteller and a gifted manager of talent. Its name is now a recognizable brand of quality.

Pixar also earns net margins of 53 percent. It has no debt. Pixar must hand over half its profits to Disney, but that relationship will end with Pixar's first release in 2006. When that happens, even if it re-ups with Disney under different terms, its financials will get a whole lot better.

Corporate Finance

Despite my preference for Pixar, I have to caution any potential investors that both Pixar and DreamWorks are very, very expensive right now. Pixar is near its 52-week high in anticipation of the Nov. 5 release of its movie "The Incredibles," which has received favorable buzz. DreamWorks is riding on its post-IPO momentum and the home video and DVD release of "Shrek 2," also scheduled for Nov. 5.

That's how these stocks will likely operate for the foreseeable future: big run-ups in anticipation of hot releases, followed by cool-down periods. That's not a ride for everyone.

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