DREAMWORKS ANIMATION FINANCIAL MANAGEMENT ANALYSIS Siede Coleman, David Ferialdi, Chris Ramirez, Chinvee Lim, Isaac Rosales
CONTENTS Overview Corporate Governance Financial Analysis Working Capital Management Corporate Debt Cost of Capital Stock Valuations Mergers & Acquisitions Multinational Operations Corporate Taxation Investor Relations Executive Suggestion
MAJOR COMPETITORS DWA's competitors are involved in both animation and live action
COMPOSITION OF BOARD MEMBERS
COMPOSITION OF BOARD MEMBERS
COMPOSITION OF BOARD MEMBERS
GOVERNANCE RECOMMENDATIONS Require independent directors to decide executive compensation and new director nominations Jeffrey Katzenberg and David Geffen combined control 68% of the voting power and as a result that could be perceived as a conflict of interest/weakness although it is legal. Another weakness concerns "gray areas" regarding board members' independence. The board determines whether independence is material or not. For example, former board member Judson Green had associations with companies (Hewitt Associates, Nokia) that were engaged in business with DreamWorks and the board deemed this connections immaterial. Create an executive committee to implement true board member independence and "controlled company exemption" on member voting
FINANCIAL ANALYSIS
AREAS OF SIGNIFICANT WEAKNESS Net income decreased from year 2011 to 2012 while SG&A increased from 2011 to 2012. The decrease in net income from 2011 to 2012 is due in part to the decline in DVD units sold, which accelerated between the years (Annual Report 2011, pg 15).
WORKING CAPITAL MANAGEMENT
WORKING CAPITAL MANAGEMENT
RECOMMENDED ACTIONS In order to reduce the cash conversion cycle, DreamWorks needs to significantly reduce its inventory. The film industry is very volatile and projecting demand for certain material may be difficult. DreamWorks has high inventory representative of productions costs. As revenue is earned on releases, DreamWorks capitalizes the costs associated with each of their movies and its amortized over a 10 year period. If they restructured this process then their inventory conversion would improve significantly thus improving their cash conversion cycle. In regards to earnings made by distributors, DreamWorks will further amortize inventory and cost of production as distributors make earnings and contributions are paid to DreamWorks.
RECOMMENDED ACTIONS However, there has been a recent trend for more digital content where customers are consuming content at their own demand, whenever they want, and has slowed growth in tangible products. Lionsgate on the other hand has 0 inventory, meaning they don t have any tangible productions and outsource inventory and content for other companies. Therefore, DreamWorks should focus on implementing their content into a more digital form, so as to create a real time, build to order system for demand, which can be intangible inventory. It is also important to note that DreamWorks Days Payable Outstanding (DPO) is higher at 220 compared to Lionsgate 149 DPO. DreamWorks is in a better cash position and has a lot more negotiating power and can delay payments to its suppliers.
CORPORATE DEBT
DEBT REVIEW DreamWorks Animation SKG only has debt in 2012. Most of the liabilities are due to accounts payable. The maturity date of this revolving credit facility is August 2017. As of the New Credit Agreement, DreamWorks is allowed to have outstanding borrowing up to $ 400 million at any one time.
DEBT REVIEW Pay a commitment fee on undrawn amounts at an annual rate of 0.375%. Interest on borrowed amounts (per draw) Lending bank's base rate + 1.50% per annum. London Interbank Offered Rate (LIBOR) + 2.50% per annum.
DEBT REQUIREMENT Borrowings secured by all DreamWorks assets Maintain a specified ratio of total debt to total capitalization ratio Maintain a specified ratio of net remaining ultimates to facility exposure Prohibit DWA taking certain actions, such as granting liens, entering into any merger, modifying organizational documents, etc. Prohibit DWA paying dividends on its capital stock
DEBT TO EQUITY Debt/Equity Ratio: 2012: $165,000 / $1,345,616 = 0.12 Debt Instruments: Notes payable is the largest portion and a small portion is current liabilities. Bank: J.P. Morgan Chase
IS DEBT TO EQUITY RATIO APPROPRIATE? YES DWA's ability to remain debt free during a teetering economy has allowed the company to avoid interest payments and expand its assets, announcing a theme park and additional studio opening this past year.
WILL DREAMWORKS MEET THEIR OBLIGATIONS? YES The interest expense is much lower than cash and cash equivalents. DreamWorks rated as AAA credit rating a decade ago, yet, today the company credit rating still A+.
DEBT RECOMMENDATIONS The company is not taking enough advantage from their financial leverage. Since debt is cheaper than equity, take on some debt to purchase back some stock. This is an opportune time considering, stock prices are at their all time lowest, giving the company an opportunity to resell the stock they receive from treasury.
COST OF CAPITAL DWA Stock Price: $19.17 Shares outstanding: 84,228 Prefered Stock: 0 Common Equity: 84,228*19.17=1,614,650 1614,650/1,779,650 = 91% Debt: 165,000/1,779,650 = 9% Debt: $165,000
WHY DREAMWORKS REPORT NET LOSS? Movie industry is volatile. There is no prediction of a film's success. A majority of a film's revenue comes from weekend box office releases. Competitive environment or low turnout can greatly make a negative difference in gross revenue. Piracy is common overseas and in United States. Family film successes are dependent on franchises well known stories will attract larger audiences than original stories if marketed incorrectly. DreamWorks subsidizes meals for their employees at the Studio, which Katzenberg refuses to decrease even in times of shrinking
WHY PRODUCT COST DECLINE? Their earnings report states that DreamWorks will adopt a new technology that will reduce their costs by $ 120 million per movie. In partnering with Twentieth Century Fox distribution, DreamWorks has also limited it's release slate to 3 films per year, whereas the company aimed for 4 films in 2013 and 2014 before the partnership.
STOCK VALUATION WORKSHEET 1. MorningStar Stock Analysts Sales growth rate from MorningStar, we believe this worksheet is more pragmatic. 2. Bloomberg Sales growth rate from Bloomberg terminal. Although the share price is higher, it is not consistent with stock analysts prediction. Sales growth rate is too fluctuate.
FUTURE FORECAST OF CASH FLOWS $17.40 based on the future forecast of cash flow. Sales growth to average 1% annually for the next five years. Cost of sales as 80%, product cost will decrease. Produce more movies every year. Release at least one sequels film every year (less risky, increase profit through home video sales, merchandising, and licensing) Average operating profit margin increase to 20% for the next 5 years because of increase in film release. Cash conversion cycle should be decrease as the days of inventory is very high, if cash conversion cycle decreas, stock price will increase.
FUTURE CASH FLOWS ANALYSIS Fair value estimates is $17 per share, as they think that the company's revenue will be more stable than in the past. Revenue growth to average 1% annually for the next 5 years. Sales 4% in 2013. Average operating profit margin decrease to 15% for the next five years because of the decline in the home video market drag on profitability. Upside case Downside case $26 per share fair value 7% average annual growth 21% average operating margins $14 per share fair value 2% average annual sales decrease 14% average operating margins
DWA SHARE PRICE CONSISTENT WITH STOCK ANALYSTS PREDICTION DWA's share price is consistent with Stock analysts prediction The uncertain transition from DVDs to digital distribution drag on profitability. Number of DVDs sales The film's library of content and franchises could make it an attractive takeover target. Reshaped the business by creating more films per year. Release at least one sequel film every year. For example, 2 films in 2013, 3 films in 2014, 4 films in 2015 and 3 films in 2016.
DWA SHARE PRICE CONSISTENT WITH STOCK ANALYSTS PREDICTION Partnership with a Russian Theme Park maker to license their characters for a theme park. DWA doesn't have expense, only revenue. Inventory decrease, carrying the cost of The Croods and Turbo. Popularity of cheap rental options from Netflix and Redbox. However, partnership with Netflix is to release an animated show based on Turbo exclusively for Netflix. The computer generated animation technologies lower the entry barriers.
HOW TO MAXIMIZE DWA'S SHARE PRICE? Increase total revenue, to not have high dependency on DVD sales and penetrate the digital media market. For instance, DreamWorks acquired YouTube channel Awesomeness TV on May 1st, 2013 that successfully enter to next generation media platform. DreamWorks has further entered this platform with its partnership with Netflix to create original content based on "Turbo", an emerging DreamWorks franchise. DreamWorks can outsource portions of their production to decrease the time to produce an animated film. Outsourcing production to other countries can also provide a cheaper alternative to productions costs.
HOW TO MAXIMIZE DWA'S SHARE PRICE? Increase company debt financing. DreamWorks Animation is highly funding the company by using Equity financing; however, DreamWorks definitely should balance their cost of capital by increasing their debt financing to decrease Weighted Average Cost of Capital (WACC). Decrease the cash conversion cycle days by decreasing the inventory. After DreamWorks launches a new film, it takes around three years to write off the inventories. Thus, finding a way for DreamWorks to return the cash faster than three years.
MERGERS & ACQUISITIONS
CLASSIC MEDIA Classic Media acquired for $155 million Classic Media has one of the most robust portfolios of intellectual property featuring many of the best known and most enduring franchises in all of family entertainment The acquisition combines DWA s hit driven business and Classic Media s extensive and sustainable library revenue stream
CLASSIC MEDIA It seems too early to tell if the $155 million price tag was too high; however, it seems favorable to shareholder value for many reasons. Classic Media is one of the largest libraries of animated characters. This bring revenue opportunities in form on character recreation, licensing, merchandise, and adaptations. In addition, the library of characters is expected to rise revenue stream during the holiday season, which is a great asset in such a volatile industry. It seems too early to value because only one holiday season has passed since the acquisition. Their stock price took sharp decline following the acquisition and has slowly increased since then.
CLASSIC MEDIA A studio s biggest asset is their library of content The advantage of having a the entire library of Classic Media comes from a new revenue creation opportunity from streaming services This is especially important in the new streaming model of Neflix, Hulu, Amazon, Vudu, etc. It is very significant in an era where all the streaming companies are all competing to have exclusive access to library content
ORIENTAL DREAMWORKS February, 2012: The $350 million joint venture between China Media Capital & Shanghai Media Group & Shanghai Alliance Investment, Ltd DreamWorks to create and have 45.45% equity in Oriental DreamWorks, a new animation company that will focus primarily on creating original film and television animation content for China and the rest of the world. The other 55% will be split among the Chinese partners Joint venture is positioned to be the leading China focused based
ORIENTAL DREAMWORKS This joint venture is too early to tell but should be positive for shareholders. China has strong box office revenues and is fairly untapped in the Hollywood market. Partners have also been proven to be leading entertainment firms in Chinese market.
ORIENTAL DREAMWORKS DREAM CENTER Partners additionally agreed on development of Dream Center in August 2012, a Shanghai Entertainment District project costing $3.1 billion. Dream Center will cover six large city blocks and will strengthen the nation s media industry while satisfying the demanding tastes of the growing middle class. It will become an entertainment zone featuring the world s largest IMAX, and a multitude of theaters
FLUCTUATIONS IN STOCK PRICE AFTER CLASSIC MEDIA DWA's share price declined after Classic Media acquisition. This is for several reasons: 1. The characters being acquired through this deal are older (most date back to the 1950s ) and previous attempts to relaunch these characters (Speedracer, Rocky & Bullwinkle, etc.) were large disappointments 2. Classic Media was considered an overvalued acquisition. In the bidding process, DWA far outbid the other prospective buyers, and the final purchase price was over 8 times the actual value of
PROFITABILITY IMPROVEMENT THROUGH ACQUISITIONS The Classic Media acquisition willbring recurring revenue each holiday without additional costs. New graphic technology adoption will save DWA $120 M per movie + decreased service and overhead labor. Classic Media as well as potential TV licensing revenue in future years estimates fair value to $20 per share from $18 after making positive adjustments for future cash flow.
MULTINATIONAL OPERATIONS
INTERNATIONAL SUMMARY China In Shanghai, China, DWA has formed a joint venture called Oriental DreamWorks with several Chinese companies. This venture will conduct significant operations in China, including the development and exploitation of original content. * DWA has also joined its Chinese partners for the release of an entertainment district in 2016, with a total investment amount of 20 billion yuan ($3.14 billion). India In Bangalore, India, DWA has a studio with about 200 artists and production staff. The company has partnered with Thomson/Technicolor to build an animation enterprise. Russia DWA has licensed its characters to Regions GC, a Russian company with plans to build theme parks in Moscow, St. Petersburg, and Yekaterinburg London, England Office obtained through Classic Media * DWA 2012 10 K (Filed Feb 27, 2013),
IDENTIFY AND ANALYZE Theatrical Distribution growth rates (from the 2012 10K report page 37). Domestic 49% to 56% International 37% to 44%
INTERNATIONAL ISSUES Political The instability of foreign economies and governments war and acts of terrorism Social Differing cultural tastes and attitudes, including varied censorship laws and the regulation of media businesses Regulatory the Foreign Corrupt Practices Act and similar laws regulating interactions and dealings with foreign government officials other laws and policies affecting trade, investment and taxes, including laws and policies relating to the repatriation of funds and withholding taxes and changes in these laws differing degrees of protection for patent rights and other intellectual property rights * DWA 2012 10 K (Filed Feb 27, 2013),
INTERNATIONAL ISSUES (CONT.) RISKS: Success is dependent on audience acceptance of our films, which is extremely difficult to predict and, therefore, inherently risky. Limited number of releases each year. Revenue comes from a single source, production of animated family entertainment. Animated films are expensive to produce; uncertainties can lead to films that are abandoned or delayed. Our success depends on certain key employees (Such as Jeffrey Katzenburg) DWA is currently in the process of developing a number of projects that are not feature films, which will involve upfront and ongoing expenses and may not ultimately be successful. * DWA 2012 10 K (Filed Feb 27, 2013),
INTERNATIONAL ISSUES (CONT.) Our home entertainment business is experiencing significant changes as a result of rapid technological change and shifting consumer preferences and behavior.piracy of motion pictures, including digital and Internet piracy, may decrease revenue received from the exploitation of our films. We are dependent on FOX and Paramount for the distribution and marketing of our feature films and related products. We depend on our distributors to remit most of our revenue and information to us Fox and Paramount distribute our feature films and related products, and the responsibility for distributing and promoting our film franchises will be split between Fox and Paramount * DWA 2012 10 K (Filed Feb 27, 2013),
INTERNATIONAL ISSUES (CONT.) Marketing costs have significantly increased and may increase in the future, making it more difficult for a film to generate a profit or compete against other films. We compete for audiences based on a number of factors, many of which are beyond our control. Global economic conditions adversely affect the profitability of our business The seasonality of our businesses could exacerbate negative impacts on our operations Our China Joint Venture faces restrictions in China and may not succeed Media and entertainment businesses in China are currently subject to a variety of restrictions, including prohibitions on the conduct of certain activities by foreign owned entities. There are restrictions on the repatriation of funds earned in China. There can be no assurances that the joint venture will be able to obtain the appropriate authorizations to engage in all contemplated aspects of its business or, if such licenses are obtained, that the joint venture will be successful * DWA 2012 10 K (Filed Feb 27, 2013),
SHAREHOLDER VALUE DreamWorks Animation is enhancing its shareholder value in its international operations by enlarging its film library. On the Income statement, the DWA Revenue has increased and a closer examination reveals that a majority of the revenue generated by the Library category was earned primarily in the international television market and worldwide home entertainment.
EFFECTIVE TAX RATE DWA loss before income taxes for the year ended December 31, 2012, the company effective tax rate was less than the 35% statutory federal tax rate due to an increase in their foreign valuation allowance. In addition, DWA s ability to benefit from certain prior year tax deductions and the net tax benefits recognized from the Tax Basis Increase is able to reduce its effective tax rate as well. Moreover, the benefit from income taxes recognized during 2010 was primarily a result of the release of substantially all of the company valuation allowance previously held against company deferred tax assets.
STRUCTURE, RATE, 3 YR TREND DreamWorks should focus on city and state tax credits by providing financial incentives and future growth opportunities to strategic operating locations. In general, the foreign box office now accounts for more than the domestic box office revenue. DreamWorks should restructure their rate using foreign opportunities. For instance they can shift R&D to Signapore or Cayman and production to India. This can allow them to charge royalties and management fees. Thus decreasing US income and increasing foreign income.
MESSAGE TO INVESTORS DWA is still best in class for generating animated hits. DWA is focusing on transitioning traditional DVD to digital sales. Viacom's deal ending in 2012 is replaced with Twentieth Century Fox beginning 2013. DWA has strong performance in Asia and partnering with Fox is a good strategic fit. Acquisition with Classic Media, DWA has the ability to extract additional value from some of Classic Media's franchises. Jeffrey Katzenberg, CEO, analyzes the competitive market landscape and acknowledges DWA losses Providesl line up shifts and labor force reduction Fto make DWA more efficient. Larry Wasserman, CFO, provided financial information on individual films as well as the earnings guidance policy.
DISCLOSURE More information could have been provided regarding what caused failure of Rise of the Guardians and what can be done to prevent such failures. It seems like they just wrote it off without taking measures something like this would happen again. DWA does mention that Rise of the Guardians managed to surpass expectations in terms of DVD sales, but the company could stand to explain this even further, as many of the questions asked in the Q1 2013 Conference Call were about this sudden change in fortune for Rise of the Guardians.
EARNINGS GUIDANCE POLICY DWA has a strong future liquidity position. DWA provided revenue and capital spending estimates for the release of their 2014 films. DWA has a new cost cutting program to save $120 million/film as well as new licensing and merchandising partnerships in progress. Future positive earnings guidance will also be attributed through digital content for a children s development series through a Netflix alliance
EARNINGS GUIDANCE POLICY From the Classic Media acquisition as well as potential TV licensing revenue in future years, the fair value estimate to $20 per share from $18 after making some positive adjustments for future cash flow. The distribution fee paid to Fox for global box office and home video rental will be 6% which is lower than the previously paid to Viacom 8%. $18 fair value estimate for DWA is unchanged. DWA tend to take a longer term perspective and put less emphasis on quarterly results given the uneven nature of the movie business.
ACCESSIBILITY TO INVESTORS DWA provides investors with necessary disclosures on their website. DWA is extremely transparent with their previous losses and their earnings guidance policy is very transparent for shareholders. Questions, concerns, and feedback are encouraged amongst investors through their conference calls, and various board members are active in responding to the questions.
SUGGESTIONS FOR IMPROVEMENT Be more consistent with film release schedules. Its imperative to release a certain number of films/year. On page 11 of the 2012 10K DWA notes that "the unexpected delay in release or commercial failure of just one of these films could have a significant adverse impact on our results of operations and cash flows in both the year of release and in the future"; DWA is falling through for 2013. The two films, Mr. Peabody and Sherman were written off for 2013. Both are back in development.
EXECUTIVE SUGGESTIONS In order to improve financial performance and shareholder value, DreamWorks Animation should continue focusing on expanding their new graphic technology to cut production costs. Inventory restructuring will also promote a healthier cash flow cycle. Moving forward, DWA can further their global expansion and business development opportunities in emerging countries. DWA should focus on developing new franchises from their newly acquired Classic Media. Partnerships with Netflix, YouTube and other digital outlets can offer new distribution channels. DWA is very liquid and could eventually vertically integrate by creating their own digital distribution platform to further expand and profit from their soon to be robust library of original live entertainment and animation content.