The Toughest Stock to Hold

Steven is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I've owned DreamWorks Animation (NASDAQ: DWA) for a while now, and I've become convinced it's the toughest equity in the universe to hold.

Okay, give me an award for exaggeration, but seriously, to all those DWA holders out there -- am I right or am I right?

We've all heard of broken/stuck stocks before, but sometimes I think DreamWorks Animation should take the top prize. It's not that stocks don't oftentimes trade in tight ranges, they do, but when you have what I consider to be a gem in the arena of computer-generated-cartoon studios at an attractive valuation based on future prospects, it becomes something of a puzzle as to why Wall Street is not showing Jeffrey Katzenberg and co. an appropriate amount of respect.

Recently, the stock perked up because some on Wall Street believe the company's upcoming animated delight, Rise of the Guardians, is going to enrich the coffers over at the House of Shrek. I can see why people are excited; the film does look interesting, with its sort-of-Avengers approach to mythical holiday icons.

Well, I don't want to be iconoclastic or anything, but I can pretty much tell you how this script is going to go. The stock will rise in anticipation of the release of Guardians. It'll attract some momentum players, and then, when the event hits the multiplexes, the stock will see a big drop. Oh, and that's if the movie is a hit. Want to know what happens if the movie is a failure? The drop will be even bigger. So you see, either way, stockholders are in for a big drop.

Can I guarantee that this will happen? No. But it seems like it has happened many times in the past (anyone out there ever hold Marvel when it was a separate beast?). No matter what the company does, the stock in the short-term may simply be at the whim of the traders who buy the hype and then sell the hype back to those who buy the hype when the hype is on the way down. That's probably another way of expressing the Greater Fool theory (and I don't mean Fool in the way that the Gardner Brothers mean Fool).

Hey, you really can't stick pins in a voodoo doll representing the DWA corporate board. In a sense, the members can't truly be blamed for the ups-and-downs of a chaotic market. They can only build the best model for making money that they can; in many regards, they have done that, and they are waiting for future executions of current long-term strategies to yield prosperous fruit in the years ahead.

One of the possible fruits that might eventually be picked is a buyout. We've all been waiting for that one, to be certain, and as time goes on, I find it less and less likely that it will happen in the next year (I was hoping, perhaps even planning, for it to be a lot sooner). Now that Katzenberg has struck a new distribution deal with News Corp. (NASDAQ: NWS), chances are that we'll have to remain patient on this count. Besides the fact that the new deal might derail a buyout scenario, there's also the question that everyone is asking: who would really want to buy the company at this point? Although it would be intriguing for Disney (NYSE: DIS) to hook up with Shrek, that isn't going to happen, and probably not only because of the Pixar issue (if you think about it, Disney probably could strike a balance between DreamWorks Animation and Pixar release dates if it put its corporate mind to it). Katzenberg left Disney years ago and entered into litgation against the company over a bonus payout, so there could still be some bad blood between the two. I think, however, that News Corp. may eventually step up to the plate and explore buying the company after it sees how the distribution deal goes. If News Corp. isn't the eventual suitor, my other pick would be Time Warner. But neither I nor DreamWorks Animation can control the prospects for a buyout.

I do think, however, there is one thing that could be controlled a lot better than it currently is: film budgets. If you ask me, the budgets for DreamWorks Animation projects -- and, in general, just about any studio film -- are needlessly high. There are ample opportunities to cut in this area.

Yet, whenever I make this argument, I am oftentimes counter-argued. For instance, I believe the development process is too long and too expensive; the counterargument is that if the process wasn't long and expensive then there would be no hits. I believe stars shouldn't be used as voices, or if they are, they should be paid a minimal amount of money since they are only using their voices and are only required to put in relatively few hours of work; the counterargument is that stars are great marketing tools for the pictures.

Both counterarguments are certainly true at times, but at other times, you can be faithful to the counterarguments and still release a poorly-received movie and lose money. That's the problem: you can spend years developing a film with the most expensive star attached and still flop just as easily a film that cost peanuts to make. It's all about risk management, and to me, the Hollywood system only cares about making money for itself via inflated budgets and does not care a whit about making a return for other people's money; remember, it's other people's money that fund the budgets (as a holder of DWA, I consider myself part of the other-people organization).

If you're an investor in DreamWorks Animation, check out a book by Nicole Laporte called "The Men Who Would Be King: An Almost Epic Tale of Moguls, Movies, and a Company Called DreamWorks." Although it is not about DreamWorks Animation proper, it does tell the story of how DreamWorks the live-action-cum-animation-studio came about way back when. My takeaway from that book was that Hollywood simply loves to throw money around; it's almost a badge of honor to give bonuses to people when you don't need to. Case in point: Laporte mentioned that, when Shrek became a hit, voice star Mike Myers received a $12 million bonus in appreciation for his contribution to the pop-culture powerhouse. Know what his original salary was? $350,000. Yes, I know Katzenberg feels it's important to share the wealth lest the star might not return for the sequel, but it still doesn't make sense to me. If the voice was recast, would it have guaranteed failure? We'll never know.

The point is that DreamWorks Animation should try to shave as many dollars as possible from its budgets in an effort to extract more economic value from its cartoons (it also would serve to reduce risk). I know holding the stock is going to be tough, but if I am to tough it out, then I need to see more effort on the board's part that my patience is appreciated. I need to see more work in terms of prudence, frugality, and all the other words that mean "lower costs, expenses, and budgets." Here's a tip: Get up-and-coming thespians to voice the characters, they're cheaper.

For now, I will continue to hold the stock. And hope that it will finally break out of its rut. Will that happen with Rise of the Guardians? Honestly, I have my doubts that we'll see a sustained rise -- no pun -- in the shares, but we won't know what will happen until it does.  

esxokm has positions in DreamWorks Animation and Disney. The Motley Fool owns shares of Walt Disney. Motley Fool newsletter services recommend DreamWorks Animation and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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