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Will Comcast Corporation Get Its Money's Worth From the DreamWorks Buyout?

Last week, in a surprise move to expand on its recent success with animated films, Comcast (NASDAQ: CMCSA) announced its plans to acquire DreamWorks Animation (NASDAQ: DWA) for $3.8 billion.

On this episode of Industry Focus: Consumer Goods, Sean O'Reilly and Vincent Shen cover the ins and outs of the deal, from the generous buyout premium for DreamWorks shareholders to the opportunities NBCUniversal has to leverage DreamWorks' vast library of beloved characters. Will Comcast be able to mimic the incredible success Walt Disney (NYSE: DIS) has enjoyed after buying up Marvel and Lucasfilm (which similarly cost about $4 billion each)?

Also, the team discusses a few consumer goods highlights from Buffett's comments at the Berkshire Hathaway annual meeting.

A full transcript follows the video.

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This podcast was recorded on May 3, 2016.

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 were written in the '90s and the early 2000s, 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 -- 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 toward 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're 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, for which you've 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 20s, wasn't it?

Shen: Which I'm sure 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 backed 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 U.S., 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 U.S. 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 1,000 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, in 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 on 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.

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!