Nightmare on Wall St. for DreamWorks
The animated studio's shares plunged this year while rival Pixar flourished. What's on tap for '06?
NEW YORK (CNNMoney.com) - I hope that DreamWorks Animation isn't paying Shrek with stock options. Dealing with an angry ogre can't be a lot of fun.
Shares of the movie studio behind the two blockbuster "Shrek" movies and this year's hit "Madagascar" have plunged nearly 35 percent in 2005. Meanwhile, shares of DreamWorks' top rival, Pixar, have surged almost 25 percent.
At first blush, the thumbs-down that Wall Street has given DreamWorks seems a bit curious. After all, investors have some good reasons to feel more positive about DreamWorks Animation (Research) these days.
Earlier this month, Viacom (Research) agreed to buy DreamWorks Animation's privately held sibling DreamWorks SKG and as part of that deal, the publicly traded studio will get $75 million in cash to pay down debt. In addition, Paramount will distribute DreamWorks Animation movies until at least 2012.
What's more, DreamWorks Animation will have two new toons out next year: "Over the Hedge," featuring the voices of Bruce Willis and Steve Carell, and "Flushed Away," which "stars" Kate Winslet and Hugh Jackman.
Paramount deal not tantamount to success
Yet, Pixar (Research) still gets all of Wall Street's love even though it still does not have a new distribution deal for movies beyond next summer's "Cars." (Of course, many industry insiders expect that Pixar will eventually forge a new deal with its current partner, Walt Disney (Research).)
So can DreamWorks Animation bounce back in 2006? Analysts are skeptical.
For one, the Paramount deal for DreamWorks SKG is not as beneficial to DreamWorks Animation as it might appear.
In fact, David Miller, an analyst with Sanders Morris Harris, said that DreamWorks Animation may find itself at a disadvantage in foreign markets. Prior to the Paramount deal, NBC Universal released DreamWorks Animation films internationally and Miller argues that Universal is a stronger studio than Paramount.
"Paramount still has to build out its international operations. What did DreamWorks Animation gain by switching distributors? We'd argue nothing," Miller said.
Dennis McAlpine, an independent media analyst, added that the Paramount deal does nothing to solve the DVD-related woes that DreamWorks Animation has faced this year.
DreamWorks Animation was forced to lower its earnings guidance in May and July because of greater-than-expected returns of copies of "Shrek 2" and "Shark Tale" DVDs from retailers.
This raised concerns that demand for DVDs, a lucrative source of revenue for the company, was starting to tail off. Pixar experienced similar problems when it released "The Incredibles" on DVD this year.
Wall Street doesn't like one-hit wonders
And despite the success of "Madagascar," analysts are still not confident about DreamWorks Animation's ability to consistently churn out blockbusters outside of the "Shrek" franchise.
"The performance of the stock is going to come down to the movies. It's that simple. And there are no sequels in store for next year," said Miller.
Sure, at 37 times 2006 earnings estimates, DreamWorks Animation may appear to be a safer bet than Pixar, which sports a multiple of 48 times next year's earnings estimates.
But despite Pixar's premium valuation, many analysts think it's still the better bet in computer animation since Pixar has better growth prospects. Jeffrey Logsdon, an analyst with Harris Nesbitt, said he rates Pixar an "outperform" compared to a "neutral" rating for DreamWorks Animation.
Making a bet on DreamWorks even riskier is the fact that Pixar's "Cars", due out on June 9, is likely to be another huge hit that could steal business from "Over the Hedge," which will be released on May 19.
So there will be added pressure on "Over the Hedge" to have a big debut in the three weeks when it won't have to compete with "Cars."
With all this in mind, it looks like the best that DreamWorks Animation bulls could hope for is that the stock starts to get some more favorable attention towards the end of next year.
At that point, investors should start speculating about how the next "Shrek" sequel will do when it comes out in 2007. "During the year, anticipation will build for 'Shrek 3.' That is the biggest variable around the stock," said Logsdon.
DreamWorks may also benefit from the 2007 release of "Bee Movie", a cartoon written by Jerry Seinfeld that has been attracting a lot of uh, buzz.
Still, until DreamWorks Animation can prove to Wall Street that it's more than a one-trick ogre (or donkey) then the returns for its stock will probably remain a lot less animated than Pixar's.
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