Sean O'Reilly: Comcast wants to learn how to train a dragon. All that and more on this
consumer goods edition of Industry Focus.
Greetings Fools! I am Sean O'Reilly joining
you here from Fool headquarters in Alexandria, Virginia. It is May 3rd, 2016, and I am here
in studio with the incomparable Vincent Shen, and we are talking all things consumer goods.
How's it going man? Vincent Shen: How are you Sean?
O'Reilly: Not too bad. Comcast came out of nowhere and said "Hey DreamWorks, we want
to buy you." This is probably a long time coming and we'll get into the reasons for
that in a minute. DreamWorks for a long time has been a value stock by most measures, plus
everybody likes Shrek and Madagascar and stuff. Before we dive in, did you happen to watch
any highlights from the Berkshire Hathaway annual meeting?
Shen: No. I've seen some of Buffett's comments, and I know that Michael from our team was
able to go out and actually attend the meeting. O'Reilly: He and Gaby did a great show yesterday.
For our listeners that don't normally listen to the financials show, highly recommend doing
that. It aired yesterday and it was a really good show. Michael went, he was in the press
box at Berkshire Hathaway, he brought us back peanut brittle.
Shen: Please listen in to the highlights from yesterday's episode of Industry Focus. We
wanted to cover some of the highlights at least for consumer focused companies here.
O'Reilly: Buffett actually didn't do a ton of talking about consumer goods brands. Classic
Buffett investments are Coca-Cola, Gillette, Procter & Gamble. It's so well known that
he doesn't spend a ton of time on them, although if you read any of those old “How to Pick
Stocks Like Warren Buffett” books that are written in the 90's and the early 2000's,
they always cite these consumer goods brands, which is our bread and butter, at least for
this show, as what he looks for in a company. We got a few good tidbits that I actually
just wanted to highlight for our listeners. The biggest of which was the red and white
elephant in the room was Coca-Cola. Do you still drink Coke, Vince?
Shen: I'm not a huge soda drinker these days. O'Reilly: You used to be though. I know I
was. Shen: Yeah. Sure. As a kid, I think everybody
-- before I guess this bigger movement towards healthier foods and trying to avoid sugary
drinks like these sodas. These companies have seen that, but Buffett still seems pretty
bullish on the company right? O'Reilly: Yeah. People in the audience and
even that hedge fund investor Bill Ackman, they've all basically criticizing Buffett’s
stake in Coca-Cola. He owns like 9% of the company, it's worth like $10 or $12 billion
or something. Coke, Ackman says it leads to obesity and it's bad for you, these sugary
drinks are just terrible for you, they aren't part of a good diet, and all this stuff.
Buffett's answer to it, which you got to give him credit, it's comical and everything, but
he notes that he gets 700 calories a day, about a fourth of his caloric intake, from
Coca-Cola and switching to water and broccoli may not make it easier to living to 100. Yeah.
That was his response to the whole diet type stuff, whatever. It wasn't at this meeting,
there was a previous meeting where Charlie Munger chimed in and he talked about how sugars
can sometimes help soften up arteries and make them less hard and all this stuff. Oh
man. Shen: I don't know if I'm going to be taking
medical advice from Charlie Munger, who I respect quite a bit.
O'Reilly: He's 92 so you could do a lot worse. Shen: There you go.
O'Reilly: Yeah. Is he 92? He's in his early nineties.
Shen: Yes he is. O'Reilly: Anyway. The other question that
was thrown at Buffett regarding Coca-Cola was executive compensation at Coke headquarters
in Atlanta, Georgia. Shen: Yes.
O'Reilly: Buffett's son took his spot on Coca-Cola's board. The board just had to vote recently
on compensation packages for Coca-Cola's management team, and it included a lot of stock options.
Buffett actually, he didn't vote for it, he didn't vote against it, he abstained.
Shen: That's a pretty significant ... That's pretty significant since they own 9% of the
company. O'Reilly: Yeah. It would be the IF team voting
on something and half the people not being there or something.
Shen: Sure. O'Reilly: Or you not voting. You're that important.
Everybody was like, why didn't you vote against it if you don't like the compensation? You've
said stock options, which these guys are getting to a large degree in the compensation package
in question, why didn't you just vote against it?
He's like, "That would go against what I want and I don't want to give the impression that
I don't broadly support the management team, which I do." and so he abstained. I don't
know. You get the sense that it's a classic Buffett move, because he does not like direct
compensation or awards or anything. […]
Last but not least before we moved on, we've talked a lot about Heinz, we've talked about
Burger King in the past. These are of course deals made by 3G Capital, the private equity
firm that Buffett's teamed up with, in particular for the Heinz deal. Again, a lot of praises
on them. Munger said he loves their cost cutting initiatives of literally getting rid of any
unnecessary expense. Coolest thing out of the meeting that I liked
was Buffett said he's in awe of Jeff Bezos' genius for making customers happy buying the
things they were already buying. I can attest to that. I love my Prime membership, I get
my detergent delivered to my door and I have a smile on my face.
Shen: Yeah. I wasn't really surprised by that comment. He's always come off as somebody
who respects talented management and somebody who's visionary.
O'Reilly: Yeah. Shen: I don't think you could take that away
from just Jeff Bezos and what he's done with Amazon for sure.
O'Reilly: I would kill to know Buffett's thoughts on Amazon's valuation, like on a P/E GAAP-type
basis. Shen: Questionable.
O'Reilly: I would love to know that. Anyway, moving on to the story of the day.
I definitely didn't see this coming, I don't think anybody saw this coming. Comcast is
buying DreamWorks. Shen: Yeah. This is a story I was really interested
to talk about today. The announcement was made actually last Thursday, and the rumor
actually broke probably that Tuesday or Wednesday. Keep in mind that with this deal Comcast,
and specifically its NBCUniversal division, will be taking over DreamWorks Animation,
integrating that into their film entertainment group. Makes perfect sense right?
Basic core details of the deal: offer price was $41 per share, which actually was quite
a premium. O'Reilly: Yeah. It was in the twenties, wasn't
it? Shen: Which I'm sure it made DreamWorks shareholders
quite happy. That's a premium of 51% from Tuesday's close, which is the price I'm using
just because that was before the rumor started getting out. There was a lot of trading activity
on Wednesday. In fact, the stock jumped 19% on Wednesday on buyout rumors and then when
the official deal was announced, it jumped another 24% following the announcement. In
all that's about a 51% premium, massive, that Comcast is paying.
I wanted to break down this discussion into two parts, just from the perspective of DreamWorks
shareholders, and then what it means for Comcast specifically. On the side of being acquired,
for DreamWorks shareholders, I think overall investors are probably quite pleased with
what is turning out to be a nice turn of events for them. The stock peaked in late 2013 at
just over $35 per share, and since then it has generally been trading at a range between
$20 and $25. They've had hits and misses at the box office.
O'Reilly: That's what I was about to comment. They've obviously had some hits like Shrek
and Madagascar and stuff, but they've had a lot of flops too.
Shen: Yes. O'Reilly: It's kind of middling along and
of course they have to compete with the behemoth that is Disney's Pixar.
Shen: We've seen that in the results too. The company's logged a net loss in three of
the past five years. A lot of their adjusted earnings numbers are turning positive only
after they back out some of these major restructuring charges that they announced, I think it was
at the beginning of 2015. We're talking about millions of dollars in terms of employee termination
contracts, but also write-offs that they took with properties that ended up not working
for them. Full year 2015 results definitely showed some
positive momentum. Revenue was up 34% and they had pretty robust growth across the company.
That included their feature films, their TV series, the consumer products, their new media.
Looking at the ticket sales from Box Office Mojo though -- this put things in perspective
for me -- of DreamWorks top 10 highest grossing movies in the US, only two of them are from
the past five years. O'Reilly: Yeah. That sounds about right.
Shen: When you adjust for ticket price inflation, that falls to just one. Only one of its top
10 best performers within the US box office at least are recent properties. A lot of their
bigger movies, their franchise Shrek for example, that finished its last film in 2010. How to
Train Your Dragon's done well for them. They have How to Train Your Dragon 3, I believe,
coming out next year. The thing is the company's definitely struggled with some of its flops.
That included Mr. Peabody & Sherman, Turbo, Penguins of Madagascar, where they basically
could not recoup all the costs they spent on production and on marketing. Definitely
I think for DreamWorks shareholders, they're happy. Katzenberg said basically this is the
deal that we've been waiting for. He's the CEO and founder of the studio.
On the Comcast side, obviously it's going to be much less of an impact. We have to keep
in mind -- I want to make sure our listeners have the context for this purchase -- Comcast
can pay for it with their cash on hand, $3.8 billion. They have about $5.6 billion I think
cash on hand. That $41 per share, they're giving DreamWorks shareholders a payout of
about 80 times their expected 2016 earnings for DreamWorks, so really, really big valuation.
At the same time, keep in mind that the film entertainment division where DreamWorks is
only going to be a part of, it still only makes up about 10% of total revenue of Comcast.
Ultimately the company still generates over 60% of its top line from its actual core cable
business. If we remember that, this deal's likely, as I'll get through the details, it's
going to be additive, it's still a very small piece of a much bigger puzzle.
Moving onto what Comcast is really getting from this. I think it comes down to three
things. DreamWorks content library, the opportunities it has to integrate that intellectual property
into other segments, especially its theme parks, and then Jeff Katzenberg.
In the first, DreamWorks has a ton of famous characters. You mentioned a few of them. We're
talking about Shrek, Kung Fu Panda, How to Train Your Dragon. They also have actually
a lot of older characters I didn't know about like Rudolph the Red Nosed Reindeer, Casper,
Lassie, I think Frosty the Snowman. O'Reilly: I can't believe they own Rudolph.
Shen: That's really big for Comcast to be able to leverage, especially with some of
their TV entertainment, their theme parks. A big project that Comcast has for its theme
park division actually, they're building a multi-billion dollar new park in China, near
Beijing. It'll occupy 300 acres, it'll eventually develop out through multiple phases to about
1000 acres. O'Reilly: Is that part of the ... You know
what I'm talking about. Disney Land or Disney World China's in a huge part outside Beijing.
Shen: That's Shanghai. O'Reilly: Okay. I'm sorry. Is that part of
it then? Shen: I'd say it's part of a wider effort
to develop these theme parks. China's becoming basically the biggest theme park market. Within
China, in that same market, which is by the way expected to soon outpace the U.S. as the
biggest box office market, DreamWorks also has some relationships and joint ventures
that I think Comcast could really leverage. Just for example, currently in China they
have basically a quota on the number of foreign films that can be shown in China as part to
protect their domestic features. I think that number's around three dozen, about 34 movies
per year now, but with the recent release of Kung Fu Panda 3, basically DreamWorks was
able to develop that with a joint venture studio in China, and they were able to release
that without being on the quota list for example. Just part of that relationship they developed
there that I'm sure Comcast wants access to, with China becoming a really big entertainment
market for them. In terms of the management, and getting back
to Katzenberg. He's going to be like a consultant now to NBCUniversal. He'll also be focused
on AwesomenessTV, which has been a big piece of growth for DreamWorks. It's basically this
millennial focused, multimedia platform. The actual leadership now for DreamWorks is going
to be Chris Meledandri who currently runs Universal's own animation studio, which is
Illumination Entertainment. Illumination itself, Comcast has already seen
some success. Despicable Me, Minions, have been huge, especially in the past two years.
I'm really interested to see what this guy Chris is going to be able to do in terms of
changing the vision a little bit. A lot of people were starting to think at least that
Katzenberg had maybe taken DreamWorks as far as he could and the somewhat lukewarm results
over the past few years and some of the box office disappointments, not really certain
anymore in terms of where he can take the company. Now you have the resources of Comcast,
its distribution platform, and where this new vision can take it. I think people are
very bullish on that. Just thinking about also, I think how Comcast
was tempted into this deal. You mentioned that it was a bit out of the blue. DreamWorks
has been a potential acquisition target multiple times now for other companies.
O'Reilly: It's been a pervasive “Oh they'll get acquired by somebody” stock for years,
and here we are. Shen: Based on some of the background for
how this deal came about that I was able to find in a report from the Los Angeles Times.
Basically Katzenberg was potentially working with Chinese investors to take the company
private. When Comcast management basically heard about this, they immediately jumped
on the deal. They flew out, met with Katzenberg, got a tour of the facilities, looked at the
financials. I think it was just maybe a week or two later they were able to announce this
deal. Really fast turnaround. Putting things, again, into context now for again some of
the competition, we've mentioned Disney, obviously they have had a string of hits based off of
their prior acquisitions of Lucasfilm for example, Marvel, Pixar--
O'Reilly: That's putting it mildly. Shen: A lot of people see that as the gold
standard of how that company has come to dominate the entertainment world. Let's just look at
this a little bit. Marvel was a $4 billion purchase in 2009 for Disney. Lucasfilm was
a $4.1 billion purchase. Right around the size of this deal for DreamWorks, $3.8 billion.
The question is, does DreamWorks have those characters and that intellectual property
that is able to generate these massive hits that Marvel and Lucasfilm have. People are
not sure about that. O'Reilly: Based upon the price tag that we're
talking about for DreamWorks, that makes Marvel look like the deal of the century right there.
Shen: At the time a lot of people had considered Bob Iger as being willing to pay top dollar
for these companies. O'Reilly: Right.
Shen: Their value obviously played out as part of that Disney ecosystem call it.
O'Reilly: Right. That's just it. When you were talking and everything, I kept thinking
to myself, the reason it works for both parties is because DreamWorks is more valuable under
the Comcast umbrella just as arguably Star Wars is more valuable under the Disney umbrella
because they can make rides and put on TV shows.
Shen: Yeah. I do believe that DreamWorks in terms of its future and where its films will
go and its TV shows and things like that, I do think there's a lot of potential in joining
with such an essentially bigger parent, with something with a lot of influence. NBCUniversal,
Universal Studios did incredibly well in the box office last year. I think they led all
the major studios actually, in terms of ticket sales.
With all of that in mind, Comcast, this is a small deal for them even at $3.8 billion
and even at that high premium. Not excusing that, at the same time I do see where they
find what they see as big opportunities in terms of in China in leveraging some of that
IP library that DreamWorks has and them basically turning this into a good deal. I think Comcast
management has proven themselves with previous acquisitions to be pretty savvy with integrating
the companies that they buy and having a good eye for what they think will be strong assets
for them. This is just another example of that.
O'Reilly: Cool. All right. Thanks for your thoughts Vince!
Shen: Thanks Sean. O'Reilly: Have a good one. If you're a loyal
listener and have questions or comments, we would love to hear from you. Just email us
at industryfocus@fool.com. Again that's industryfocus@fool.com. As always, people on this program may have
interests in the stocks that they talk about and The Motley Fool may have formal recommendations
for or against those stocks, so don't buy or sell anything based solely on what you
hear on this program. For Vincent Shen, I am Sean O'Reilly. Thanks for listening and
Fool on!