With 43.7% of the float already shorted, DreamWorks Animation (DWA) is one of the most heavily shorted stocks out there. While it has had a heavy short interest over the past several years, it has oscillated between 20-40% in the past year alone.
Is this skepticism warranted, or is there hidden value that the shorts are missing?
The Business
DreamWorks Animation creates and sells branded family entertainment, including animated feature films, television series and specials, live entertainment properties and related consumer products. In total, the company has released 30 animated feature films, including recognizable franchise properties such as Shrek, Madagascar, Kung Fu Panda and How to Train Your Dragon.
Feature films currently comprise the bulk of revenues and profits. DreamWorks aims to release approximately two animated feature films per year. The company generally retains the exclusive copyright and other intellectual property rights in and to all of its films and episodic content and characters.
The filmmaking process starts with an idea. Inspiration for a film comes from many sources—from in- house staff, from freelance writers or from existing literary or other works. Successful ideas are generally written up as a treatment (or story description) and then proceed to a screenplay, followed by the storyboarding process and then finally into the production process. Excluding the script and early development phase, the production process, from storyboarding to filming out the final image, for a full-length feature film can take approximately three to four years.
Disney/Pixar (DIS), Sony Entertainment (SNE), Fox Entertainment’s Blue Sky Studios (FOX) and Illumination Entertainment represent the closest competition, with similar target audiences and comparable animated filmmaking capabilities.
History
Prior to the separation from Old DreamWorks Studios on October 27, 2004, the company was a business division of Old DreamWorks Studios, the diversified entertainment company formed in October 1994 by Steven Spielberg, Jeffrey Katzenberg and David Geffen.
On October 28, 2004, DWA common stock began trading by the direct transfer of certain assets and liabilities that comprise the current business.
The company presently conducts business primarily in two studios—in Glendale, California, and Redwood City, California. The Glendale animation campus, where the majority of its animators and production staff are based, was originally constructed in 1997. DreamWorks plans to close the Redwood City studio and consolidate its business operations to the Glendale animation campus during 2015.
Growth Opportunities
DreamWorks is currently producing seven feature films. One is expected to release in 2015 and two in each of 2016 through 2018. The company has a substantial number of projects in creative and story development and production that are expected to fill the release schedule in 2019 and beyond.
* They are also using a third-party production company to produce a feature film based on the Captain Underpants book series. This film, which is being produced at a significantly lower budget than their other feature films, is expected to be released in 2017.
In addition to the creation of feature films, DreamWorks is engaged in a number of initiatives to more fully exploit its franchise and other properties and diversify its revenue streams. These include the development and production of TV series, merchandising, and character licensing.
Over the last several years, the company has greatly expanded its licensing of characters and other intellectual property for use in location-based entertainment, such as cruise ships, amusement parks and shopping malls. For example, since 2010 it has had a licensing arrangement with Royal Caribbean International allowing them to incorporate characters into live shows and other entertainment on certain cruise ships.
In 2015, the CFO expects 50% of revenue will come from non-feature film content. Important sources of income besides feature movies are:
- Television content: includes YouTube (GOOG) and Netflix (NFLX) deals.
- Consumer articles: this includes toys based on DreamWorks' characters but also licensing deals to use the characters to sell serial or build DreamPlaces
- Library revenue: diversified catalog of 30+ movies that still make money
Valuation
Ancillary revenue sources are a main contributor to analysts expecting $0.70 EPS next year.
Still, using GuruFocus’ DCF Tool, we can estimate that investors are still pricing in >20% annual EPS growth over the next ten years.
For a company that has struggled with profitability over its decade-long history, this would be a difficult feat.
Even during its most successful period in history (2005-2010), the company averaged EPS of around $2.00. Even if they somehow managed to have EPS of $2.00 this year, DreamWorks would still need to grow EPS by over 6% annually for the next 10 years for the current valuation to be reasonable.
Conclusion
While the company has some exciting growth drivers moving forward that should diversify its revenue streams, the current valuation is simply too much. Until there is a massive pullback, it looks like the better position is to be short.
For more ideas like this one, check out GuruFocus’ High Short Interest Screen or the rest of R. Vanzo’s Articles.
