What Went Wrong at DreamWorks Animation?

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Paul Sakuma/APCEO Jeffrey Katzenberg says he is taking on a more hands-on role at DreamWorks Animation, which just went through another round of layoffs.
The feature films released by DreamWorks Animation (DWA) are typically frothy entertainments that feature happy endings. In real life, though, the studio itself might not have such a cheerful final act.

The company has had to take writedowns for four of its last six films, and it's posted a net loss in two of its preceding four reported quarters. Recently, it announced layoffs that will send around 20 percent of its staff packing. Overtures to potential buyers haven't yet succeeded. How did the company fall this far?

Different Movie, Same Ending?

In some ways, these developments shouldn't come as a surprise. After all, the entity that DreamWorks Animation was spun off from (and derives its name from) was pegged for major success only to fall far short of the mark itself.

This was DreamWorks SKG, an omnibus entertainment company founded in 1994 that was supposed to be a major power in film, TV and music.

On the film end, the idea was to create a new big-time live-action and animation studio that could stand toe to toe with Hollywood majors like Disney (DIS), Viacom's (VIA) Paramount and 21st Century Fox's (FOX) 20th Century Fox.

But DreamWorks SKG, in spite of a few successful movies and a formidable talent roster, couldn't compete with the well-diversified operations of its rivals. Disney, for example, not only makes money from its movies, but also owns a set of broadcast TV assets like ABC and ESPN, and operates hugely popular theme parks.

After DreamWorks Animation split from its parent, going public in a 2004 IPO, DreamWorks SKG only lasted another year as a stand-alone company. In 2005, it was sold to Paramount.

Standing Alone

Like its former parent, DreamWorks Animation aimed to succeed largely on its own as a big-time producer of movies.

That's a risky proposition to begin with -- feature films, after all, are awfully expensive to make and distribute. Animated ones are even more labor-intensive than their live-action counterparts, and they take far longer to develop.

So the company is under the gun to a much greater degree than its major studio peers. First, the major studios have a bigger slate of releases, meaning more chances for a hit. And second, they're better diversified across other media and businesses, which helps to cushion the inevitable flops.

Trolls Film Due in 2016

For example, in 2012 Disney released the sci-fi epic "John Carter," a notorious bomb. But thanks to the performance of some of its other releases that year (like 2012's top domestic grosser, "Marvel's The Avengers"), plus its non-film business units, overall the company was a stellar performer. It netted an annual profit of $5.7 billion on revenue of $42 billion.

And that's DreamWorks Animation's problem. In short, it's stuck producing expensive films that take a long time to bring to the screen, and it isn't sufficiently hedged against losses.

As a result, the company has only released two or three films every year since its IPO. If only one of those movies tanks, it can easily plunge the studio into the red.

And despite efforts at diversification -- purchasing the license for the Trolls line of dolls in 2013 (its Trolls film is slated for release in 2016), supplying several animated series to Netflix (NFLX) and starting an in-house publishing imprint -- DreamWorks Animation remains overwhelmingly dependent on film releases. In the third quarter of 2014, for example, almost 80 percent of its total consolidated revenue came from this source.

Cost Cuts and For-Sale Signs

DreamWorks Animation has set goals for cost savings, announcing that it aims to reduce its per-film production expenses to around $120 million (the latest release, "Penguins of Madagascar," cost around $132 million).

Starting next year, it also intends to stick to releasing only two movies every year, one from original material and one a sequel to an existing property.

It seems a lower per-film cost and fewer releases means fewer troops necessary to make them. Hence the announced layoffs -- which, by the way, are not the company's first. It let go of around 350 employees in 2013.

The company is also reorganizing, with several top executives stepping down and CEO Jeffrey Katzenberg saying that he will take a more hands-on role in both development and production of upcoming titles.

Meanwhile, DreamWorks Animation has been trying to sell itself to outside parties -- basically, turning it into a unit of a larger company as with the major Hollywood studios. There have been no takers yet.

So the company will keep pumping out movies as a stand-alone entity. But the question is, for how much longer? After all, the movie business has been a pretty rough place for lone wolves lately.

Motley Fool contributor Eric Volkman owns shares of Walt Disney. The Motley Fool recommends DreamWorks Animation, Netflix, and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.​
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