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The rationale behind NBCUniversal's DreamWorks Animation bid


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The rationale behind NBCUniversal's DreamWorks Animation bid

After much speculation over the years, DreamWorks Animation SKG Inc. as a stand-alone film studio,with all its troubles and assets, could soon be a thing of the past.

Comcast Corp.'sNBCUniversal Media LLChas agreed to buy thecompany in a deal valued at $3.8 billion, purchasing the studio's existing sharesfor $41 apiece in cash. DreamWorks' market capitalization on April 21, one weekbefore the acquisition announcement, was just $2.34 billion, representing a roughly62% premium. With the studio will come intellectual property like Shrek and Howto Train Your Dragon, as well as a stake in digital unit AwesomenessTV.

The April 28 deal announcement comes after what many analystsregard as several years of questionable performance, though the animation studioseemed to be on the cusp of a turnaround by the end of 2015.

SNL Image

DreamWorks Animation beat consensus earnings estimates in 2015for the first time since 2012, according to S&P Global Market Intelligence.Top-line revenue climbed33.8% for the full year after dropping in the prior two years. The 2015 top-lineresult represents the best performance since 2004, when the company collected almost$1 billion worldwide for "Shrek 2."

Further, DreamWorks managed to expand its Television Series andSpecials revenue, which includes its series deal with Netflix Inc., by over 100% in 2015, and its New Media segment,which primarily consists of AwesomenessTV, also grew substantially, according tothe company's annual Form 10-Kfiling.

But the company's primary source of income is still feature films,which accounted for 56.8% of revenue in 2015, down from 70.8% two years prior. Thatchange in mix was largely due to deals like that with Netflix and AwesomenessTV.

With the boost in revenue and diversification seems to have comea boost in value. Just a year and a half prior, toymaker Hasbro Inc. was in talksto pick up the animation firm in a rumored $2.3 billion deal. That transaction wasbeing negotiated in the second half of 2014, a tough year for DreamWorks. The company's releases at thetime were not meeting expectations, and its TV and digital units were still nascent,comprising about half the revenue they did in 2015.

"Their TV business and the deal they have with Netflix andeverything, it's sort of stabilizing their revenue, but they're still dependenton how their films do. When you talk about one to two films a year, and if one doesn'tdo well, that can really affect things in a big way for them," said SNL Kagananalyst Wade Holden in an interview.

But Holden was still positive on the NBCUniversal merger. Henoted that DreamWorks Animation's distribution deal with 21st Century Fox Inc. ends in 2017, so NBCUniversal can pickthat up seamlessly without going through "the whole dog and pony show"of negotiating another favorable deal.

For Comcast's part, it will get access to "a strong libraryof content." The analyst pointed to Shrek, How to Train Your Dragon and KungFu Panda as franchises with some value still in the tank. Leveraging those propertiesacross the company's Universal theme parks will also add value.

Moody's analyst Neil Begley agreed. Under Comcast and NBCUniversal,DreamWorks will "be able to take a lot of what they're doing to a higher level.I think that's the opportunity for them."

He called the digital assets "icing on the cake." AwesomenessTVis a leader in the burgeoning world of short-form digital content, and they counthundreds of millions of primarily young people as monthly viewers. Comcast doesnot have a property to match. Its Stream TV is limited in content, usability andscope, Begley said.

"When you think about the platform that Comcast has, itcould be a major staging point for businesses like AwesomenessTV," he said.

This deal is coming at a time when DreamWorks is successfullyrealigning its business, he added. After decent box office results in 2013 and somestock-market spikes driven by quarterly earnings results, the studio got ahead ofitself by taking out debt and making acquisitions, Begley said, especially as 2014stretched out into 2015 with largely disappointing performances.

His firm downgraded the studio in the summer of 2015, but maintainedits "stable" outlook despite the company's high leverage. Begley believesthe company's restructuring plan, which put the focus of CEO Jeffrey Katzenbergback onto animated features where the executive tends to do his best work, wouldyield positive results.

For this deal, the price looks too high for short-term considerations,Begley said, and the fact that Comcast is paying in cash could leave their metricslooking "a little ragged" for the near term.

"But I think it's really a longer-term view these folkswould be taking," he said, pointing to the integration of over-the-top anddigital assets as well as theme park and distribution opportunities.

But not all analysts agree with Begley's optimism.

Vasily Karasyov of CLSA has been bearish on DreamWorks Animation,and the deal talks did not change his opinion. Karasyov reduced his earnings estimatesdownward in his most recent note and maintained a "sell" rating on thestudio.

"Our SELL rating is based on our belief that consensus significantlyoverestimates the company's earnings power. The pushback we get is that this argumentwas only true before the restructuring announced in January '15. We point out, however,that the Street currently expects 2016 EBITDA and EPS 24% and 39% below what itexpected a year ago, respectively. So the pattern hasn't changed," Karasyovsaid in the note.

On the Comcast/NBCUniversal deal, he said it "makes no sense."

"Universal is a film studio. Why do they need a small operationthat ekes out a title a year, or two, that in the best case break even? What's thepoint?" he said in an interview.

Where Holden pointed to the worldwide box office total of "KungFu Panda 3," noting that it performed well enough at over $500 million, Karasyovnoted that that figure is still almost 20% below prerelease expectations. Domestically,it only struck $140 million.

"It will barely break even. It's not a franchise when youhave $140 million," he said.

On theme parks, Karasyov argued that NBCUniversal could licenseDreamWorks IP if it wanted to, but "nobody wants those properties."

AwesomenessTV is an acceptable holding, the analyst said, butafter a recent deal withVerizon Communications Inc.,which valued the unit at $650 million, DreamWorks is left holding only 51%, whichdoes not support a $3.8 billion valuation, he added.

Karasyov believes that DreamWorks and its stakeholders have beenlooking for a liquidityevent for some time, engaging unsuccessfullyin talks with both Hasbroand SoftBank Group 2014 largely because it is demanding a high valuation without turning its franchisesinto blockbusters. With Comcast already owning a very successful content unit aswell as the infrastructure and balance sheet to make more targeted investments indigital video, the analyst was at a loss for an explanation.

"There is no logical reason for this deal to happen,"he said.