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The View from Wall Street: Weak “Turbo” Opening Highlights DreamWorks Business Model Erosion

Following the lackluster opening of Turbo, DreamWorks Animation heard grumbling from Wall Street this afternoon, with shares in the company losing over 5% of their value on NASDAQ. Sterne Agee analyst Vasily Karasyo released a report this morning that offers a big-picture perspective on DreamWorks and explains why the weak Turbo debut highlights the erosion of DreamWorks’ business model, which relies largely on a few tentpole films every year.

Of course, DreamWorks management is well aware, too, that their reliance on blockbusters is not a sustainable long-term model, which is why Jeffrey Katzenberg is scrambling to diversify into other areas, such as acquiring Classic Media’s library, entering the Chinese animation and amusement park markets, and working with Netflix to create online series.

Here is Karasyo’s report:

Price: $24.90
Price Target: $21.50
Weak Turbo Opening Highlights Business Model Erosion

Our Call
We believe that the weak opening of Turbo is not a one time event but another illustration of the challenges to DreamWorks Animation’s business model due to decreasing box office opportunity and high legacy production and releasing costs. Although the management’s efforts to build new revenue streams received a lot of attention recently, they are not enough to offset decreasing film profitability. We reiterate our Underperform rating.

  • We estimate at this point that Turbo will generate $70 mln at the domestic box office, less than half of our and the Street’s pre-release estimate of $160 mln. A significant number of international territories don’t open till October but assuming IBO is in line with our forecast at $280 mln, we expect a $19 mln write-down which would drive $0.28 downside to our FY13 forecast. We don’t believe the company has to make a determination on the title’s profitability and therefore the write-down won’t happen until Q4.
  • If we are right about Turbo’s ultimate profitability, the risk to FY14 estimates is now significantly higher. There are two original releases, Peabody and Sherman and Happy Smekday, next year. With two out of the last three titles underperforming, we see the likelihood of another write-down as materially higher.
  • New revenue streams from the recent Netflix (NFLX – $264.58 – Neutral, Bhatia) deal only modestly decrease dependence on film earnings: we estimate they will account for $0.07 in EPS in FY14 assuming there are no execution issues. By comparison, Rise of The Guardians write-down impact on EPS was $0.68 and The Croods contribution to FY13 will be $0.26.
  • We think the execution risk associated with the Netflix deal is overlooked. In recent history, the company pursued several initiatives to drive incremental revenue which ran into challenges and did not yield expected results, e.g. Penguins of Madagascar consumer product licensing program and a shift to three films a year. The main challenge of the Netflix deal, in our view, is to produce high volume of content within tight time frame and at the target margin.
  • Matt Sullivan

    I saw Turbo last night and was pretty entertained. Pity…

  • Matt

    Even though I have not seen Turbo it looks like a decent film. I think the reason that DreamWorks is having a hard time as of late is that they are putting out too much product. This has happened time and time again. Disney tried it many years ago with their 2d films and failed and DW has followed suit. We do not need 2 animated films a year from a studio. The marketplace becomes overcrowded and also unemployment is still very high which keeps people away from spending on every film that comes out.

  • Strong Enough

    too many movies. dreamsworks will never learn

  • Patrick

    This must be a thrilling day for you Amid.

  • GW

    Well, the answer to your opening question might as well be Soviet Russia. Music and the visual arts in general didn’t do well in Soviet Russia, but the animation industry, though small, did well. They didn’t have to worry about conforming to standard lengths of material so there were more mid-length animated films. After the Kruschev Thaw in the 1950’s Soviet Russia became more liberal and gave creators opportunities to express themselves. On the other hand there’s all sorts of social responsibility films that bore the hell out of anyone from outside communism. Without shareholder revenue, there very well could be an animation industry but there wouldn’t be an animation business.

    In fact, it may be that a whole society could be run without a monetary system. Here’s a website promoting the idea of a resource economy: http://thevenusproject.com/the-venus-project/resource-based-economy

  • DWA exec

    But what about our glorious 5 year plan???

  • Nikolas

    I might note there are no longer any Pixar (PIXR) shares. After Pixar was bought by Disney, all Pixar shares were converted over to Disney (DIS) stock.

  • George Comerci

    I saw it on opening day and loved it! Cant believe everyones hating on it

  • IamSamJackson

    Agreed. All of them are quick gags and same old same old stuff.

  • iamsamjackson

    Why does it cost the folks who created Despicable Me take 70 Mill to make a movie Dreamworks 135?

    • GW

      I’m no expert but part of it is the use of matte paintings in many shots instead of 3D sets and the other, more obvious part is that they skimp on details on the characters. Surely there’s more to it than that, but those two things add up to a certain amount of cost savings.

      • Kevin Martinez

        Also, much of the heavy lifting is done overseas and/or by freelancers. Not something to aspire to.

        If Dreamworks, for all its successes and profitable franchises, cannot afford an underperformer or two, what does that say about the sustainability of the current Hollywood animation model?

      • Funkybat

        I wasn’t aware that they used matte paintings for BGs in Despicable Me/DM2. If so, I think that’s a brilliant creative and production flow move. I see so much incredible concept art in all of the “making of” books for today’s 3D features, and often feel it’s a shame that it all has to be translated into polygons and shaders. There were some lighting studies for Wreck-It Ralph that looked as believable or MORE so than the actual backgrounds in the film!

        Obviously, if you are moving the camera through the scene, or even having more than a minor pan one way or another, you need a true 3D environment. But for establishing shots or other more static scenes, why NOT use a beautiful matte painting instead? If the viz dev team is already creating things like this, just take it the extra mile and make it detailed enough to “work” in the film.

    • Bloat….burp.

      It couldn’t have anything to do with bloated middle management, and “creative executives” and such though… Nah… . couldn’t be that.

  • Brian Mitchell

    Well, I guess it’s time to shut down the good ‘ol computer animation studio, because obviously…nobody wants to see computer animated films anymore.

  • Hunter

    There’s been like, three or four? posts about Turbo and so far everyone who has seen the film mentioned that it was entertaining while everyone else just criticizes it without stating whether or not they’ve actually seen it or they’re just pretending they have to voice their opinion on a movie whose only footage they’ve seen is the ones in the trailers…

    Like, how many people here have actually seen Turbo?

  • Jen Hurler

    As much as I’m sure I’ll be shot down for this, this reminds me a lot of Walt Disney’s forays into other areas, mainly theme park dev and television. Just on the surface though! I know they aren’t the same situation, but that was the first thing I thought. It seemed like the right step when they cut down the number of films they’d make after Rise of the Guardians disappointed, despite that being terrible for artists overall. Oy…it just seems like no one wins with they current system in place.

  • DM2 is technically Illumination, not Sony, but your point is definitely still valid.