DreamWorks: Feeling Flushed

Analysts are less than impressed by the animation studio's strong results and doubt its other releases can match the Shrek pics' success

The fairy tale could be over for shareholders of DreamWorks Animation (DWA), the studio responsible for the computer-generated fantasy Shrek. On Nov. 1 the Glendale (Calif.) studio's share price brushed a 52-week high of $29.40 after it announced third-quarter results that beat Wall Street expectations. But in the face of intense competition, analysts are divided on whether the computer-generated imagery (CGI)-focused filmmaker can maintain its animated performance.

The stock had already pulled back to $27.68 by the Nov. 2 close, the day before the release of DreamWorks Animation's latest animated feature, Flushed Away, a sophisticated romp that pits rodents against reptiles in the London sewer system.

The cartoon studio, spun out from DreamWorks SKG in a 2004 initial public offering, operates on a schedule of two releases per year. The studio expects to release Shrek the Third, part of its juggernaut series about a comical ogre voiced by the comedian Mike Myers, next year. Shrek 2 won 2004's domestic box-office crown. In 2007, DreamWorks Animation will also release Bee Movie, featuring the voice of sitcom legend Jerry Seinfeld.

A recent report from Morningstar (MORN) rates DreamWorks Animation's stock a hold, with a fair value estimate of $25 per share. The report lauds Shrek's box-office and home-video performance and says there is an expectation to see more of the same "for years to come." But the report points out that DreamWorks Animation hasn't produced anything else in the same ballpark. Movies like Shark Tale and Madagascar have brought in "decent profits for the firm but haven't been able to offset losses from bombs like Sinbad and The Road to El Dorado" Overall results have been "lumpy," Morningstar says.

British Collaborator

Meredith Fisher, an analyst with Jefferies & Co. (which makes a market in the company's shares), is more bullish. After the company announced third-quarter results—earnings of 10 cents per share against expectations of a slight loss—she upped her rating to buy from hold. She also raised the target price to $31.50 from $27.50. Home video sales of the film Madagascar powered the quarter.

Fisher conceded in a Nov. 1 report, however, that since Flushed Away is a collaboration with Aardman Animations, a British studio best known for its characters Wallace and Gromit, that "we don't think 'the Street' has great expectations for the film." But Fisher adds that DreamWorks Animation stands to benefit from an upcoming film schedule. None of the movies are collaborations with Aardman, which has not put up Shrek-like numbers for its own films, including Chicken Run. For 2008, DreamWorks has slotted a sequel to Madagascar and a new picture, Kung Fu Panda. Fisher sees 2007 revenues climbing to $688.2 million, up from an estimated $342.4 million for 2006.

Since 2000, DreamWorks Animation's most prominent competitor, Disney's (DIS) Pixar, has released fewer than one film per year; its own rodents-in-Europe movie, Ratatouille, is due out next summer. Though less prolific, Pixar has had more successes, including Toy Story, the first full-length CGI movie. But other competitors have drawn in viewers as well. This year, Twentieth Century Fox's (NWS) Ice Age: The Meltdown outperformed DreamWorks Animation's earlier offering Over the Hedge.

Paul Allen to the Rescue

Merrill Lynch (MER) analyst Jessica Reif Cohen writes in a recent report that the next Shrek installment will be an "inflection point in operating fundamentals" for the studio. She has a price objective of $31 for the stock. (Merrill seeks business relationships with the companies it covers.)

The stock may also have another catalyst coming, thanks to a big-name shareholder. Billionaire investor Paul Allen has said he will trigger a secondary share offering in DreamWorks Animation after the release of Flushed Away. The secondary offering will dissolve a holding company established to oversee the stakes of Allen and other major stakeholders. Before the IPO, Allen had invested $700 million in the company, and Fisher and other analysts estimate that he, along with other investors, could reap more than $300 million from the secondary offering.

The dissolution of the holding company, which had special voting rights, makes the stock a "less complicated story," Fisher says. And she sees the possibility of a stock buyback or, less likely, a special dividend, to reward investors in the future. Bear in mind, though, that the studio's—and the stock's—future success in large part remains in Shrek's big green hands.

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