A Scary Picture at DreamWorks


By Ronald Grover Wall Street's concern with DreamWorks Animation was summed up quickly by Kathy Styponias, the highly respected Prudential Equity analyst, during a July 11 conference call: "Help us feel comfortable...that sales of 50 million DVD units [of the 2004 blockbuster Shrek 2] are still achievable," she said. Ouch.

For DreamWorks Animation (DWA), which has produced such megahits as the two Shrek flicks and last year's Shark Tale, credibility on Wall Street has been tough to come by since its highly visible Oct. 28 initial public offering. The studio, started by moguls David Geffen, Jeffrey Katzenberg, and Steven Spielberg, raised $933 million that day, with the stock jumping to $38.75 from its $28 offering price. Until recently, it had been hovering around $26.

ENTER THE REGULATORS. Then, on July 11, DreamWorks announced it was reducing its earnings estimates for the year to between 80 cents and 90 cents a share, down from the $1 to $1.25 it had projected as recently as May. That was enough to push the stock down by some 13%, to close at $23.27 on July 11. The culprit: a still uncertain DVD market that has forced reduced estimates of sales for Shrek 2 DVDs, from 55 million units to 50 million units (see BW Online, 7/1/04, "End of the DVD Party?").

DreamWorks had other news -- both good and bad -- for the market. It's scrapping, at least for now, a planned secondary offering that mostly would have benefited billionaire Paul Allen, who owns 59% of the animation studio.

Plans for that offering had rankled analysts, who feared Allen would sell a large -- but not majority -- share of his holdings early on. Merrill Lynch analyst Jessica Reif Cohen remains worried that DreamWorks didn't rule out coming back to the idea, writing in a July 11 research note that the outfit is now saddled with an "overhang," which could continue to depress the stock.

SLIPPED DISKS. The company also said it had been notified by the Securities & Exchange Commission that, on the heels of several shareholder lawsuits claiming the company misled investors, an informal inquiry had been opened into DreamWorks Animation stock trades. DreamWorks Animation says it is "voluntarily complying" with the SEC, adding that it had been told by regulators that the investigation "should not be construed as an indication that any violations of law have occurred."

There's more. DreamWorks CEO Jeffrey Katzenberg admitted that the most recent animated picture, Madagascar, will gross only about $190 million at the U.S. box office. Before the movie opened, studio executives had said it was testing better than Shrek, which grossed $267 million when released in 2001. Katzenberg was asked about what impact lower box office would have on Madagascar DVD sales, which are generally pegged to a film's box-office performance. No clear answer was given.

Indeed, DreamWorks, like all of Hollywood, seems unclear on what's happening in the overall DVD market. Katzenberg said it's too early to tell if the market is cooling faster than expected, and that there is "way, way, way too small of a sampling of [consumer] behavior."

SOFT FORECASTS. Still, he has sent out teams of executives throughout the world -- one just departed for Australia -- to see if a buildup in inventory of old TV shows and other DVDs may be crowding out newer releases. DreamWorks releases its DVDs through General Electric (GE) unit, NBC Universal, which is also involved in the extensive review of the market, executives say.

DreamWorks' inability to give a clear answer to the direction of the DVD market upset at least one analyst. Fulcrum Global Partners' Rich Greenfield wrote that "we are troubled by the inability to properly forecast earnings" and downgraded the stock from buy to neutral. And he isn't the only concerned analyst. Merrill Lynch's Cohen wrote that the weak DVD market might be a "strong signal" that DVD sales of Madagascar may be affected, despite earlier suggestions that the film "was on track with its expectations."

And DreamWorks itself sent up yet another cautionary flag: Chief Financial Officer Kris Leslie indicated that the current and recently lowered projections for the year are based on a $170 million worldwide box-office gross for the studio's next offering, the claymation flick Wallace & Gromit: The Curse of the Were-Rabbit, scheduled for release Oct. 7. If Wallace & Gromit fails to deliver, DreamWorks' stock could take another blow.

CELEBRITY SOUNDS. The studio's job now is to keep Wall Street happy until next year, when it's expected to have a major hit with the film Over the Hedge, which features the voice of Bruce Willis. Its big year could be in 2007, however. That's when it expects to release Bee Movie, created by comedian Jerry Seinfeld and using his voice. The studio also will then release its third Shrek film.

DreamWorks has high hopes for all its upcoming flicks, of course. And in some cases, those hopes may prove to have been justified. But high hopes -- and even monster hits -- don't always guarantee Wall Street credibility.

Grover is BusinessWeek's Los Angeles bureau chief


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