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Analysts Weigh in on DreamWorks Animation's Fox Distribution Deal

Dreamworks Animation Logo - H 2012
Dreamworks Animation

UPDATED: Observers say News Corp.'s film unit will get a high-margin new revenue stream and there is international upside for DWA, but they disagree on the deal's financial benefits for the studio.

Wall Street overnight started chiming in on the late Monday distribution deal announced by DreamWorks Animation with News Corp.'s Fox, with analysts assessing the financial winners and losers.

Stifel, Nicolaus analyst Benjamin Mogil in an investor note discussed the financial benefits for DWA. "While the deal is slightly better than the current one, and Fox is a strong partner, it does not change our view that the company will continue to see gross margin pressure amid home entertainment revenues given the continued production and [advertising] cost levels," he said in maintaining his "hold" rating on DWA's stock.

For DWA, the new Fox deal comes at the same 8 percent fee as its expiring deal with Viacom's Paramount, but "allows for the domestic television rights (pay TV, Netflix, cable, free) to be carved out from the deal," while digital distribution revenue comes at a 6 percent fee "reflecting the lower costs associated with these revenues," Mogil explained.

Most of those terms were as he had forecast, but "the lower digital fee is positive compared to our expectations," Mogil said.

But Lazard Capital Markets analyst Barton Crockett said the deal isn't quite as good as he had expected for DWA. "The terms, while improved, are not quite the step up we had assumed," he said. Combining the effects of the 6 percent and 8 percent fees, he said "the total effective fee" is about 7 percent, compared with his expectation for a 6.5 percent fee, which the analyst said slightly trims his earnings expectations going forward.

While DWA is paying only a 6 percent fee for emerging digital distribution opportunities, such as electronic sell-through, VOD and online rental, "DWA home video sales, aimed at kids, are mainly DVD, so the impact of the new tech exclusion is limited initially," Crockett predicted.

Fox will be a strong distribution partner for DWA in today's more global box office game, Mogil highlighted. "With the international markets, particularly the emerging ones, the key driver in global box office, the choice of Fox is strategically sound," he said.

Cowen analyst Doug Creutz went further. "With Fox's strength, upside could come from international markets," he said. "Given the size and experience of Fox's distribution business overseas, there could be upside to our forecasts if Fox is able to help DWA's films perform better in international markets."

Explained Creutz: "Evidence suggests potential here as animated films distributed by Paramount have earned an average international multiplier of 1.85x versus a 2.19x for animated films distributed by Fox over the past eight years."

Janney Montgomery Scott analyst Tony Wible suggested though that overall, for DWA, "the strategic benefits are far greater than the economic benefits." He explained: "The deal aligns economic interests with a competitor (News Corp.'s Blue Sky Studios), which should eliminate overlapping release windows. Furthermore, News Corp. may be instrumental in helping DWA launch a new TV channel that leverages DWA/Classic Media content."

Meanwhile, analysts said the new distribution relationship will be positive for Fox, but could put additional pressure on Paramount to add new content to its pipeline.

"The deal, we estimate, will drive close to $75 million per year in high margin new fees for News Corp., worth about a 2 cents to 3 cents after tax lift to earnings per share," Crockett estimated.

And Mogil's Stifel, Nicolaus colleague Drew Crum said that "Paramount loses a high margin distributor's fee (8 percent of gross revenue) and may need to pursue additional cost cutting initiatives in order to maintain profitability."

But he also highlighted that Paramount is only a small contributor to Viacom's overall financials. "To put it into perspective, Paramount represents only 7 percent of Viacom's estimated fiscal year 2012 adjusted profit," he said.

Email: Georg.Szalai@thr.com

Twitter: @georgszalai