Analysts: A DreamWorks Animation Merger Makes No Sense For Hasbro

Hasbro is in talks to acquire DreamWorks Animation, according to reports from Deadline and The New York Times.

As a result, DWA's stock is soaring early Thursday.

A merger with Hasbro would be great for the CEO Jeffrey Katzenberg and the studio - its movies have been on an up and down roller coaster at the box office - but it's not clear how it would aid Hasbro, which has seen profits rise due to its Transformers toys and a lucrative deal with Disney that has resulted in popular Marvel and Star Wars lines.

The company recently announced a film label named AllSpark Pictures (a nod to "Transformers"), but it already has a big lineup of film adaptations in the works for brands including "My Little Pony," "Monopoly," and "Candyland," "Magic the Gathering," and "Jem."

In a note, media analyst Vasily Karasyov of Sterne Agee writes three reasons rumors of a merger between the two companies makes little sense for Hasbro.

1. DreamWorks Animation is "facing serious challenges"

Three of DWA's past five films - "Mr. Peabody & Sherman," "Turbo," and "Rise of the Guardians," - have been flops. When "Rise of the Guardians" performed worse than expected in 2012, it led to layoffs at the studio. Recently, DWA took a $57 million write down on "Mr. Peabody & Sherman."

Earlier this year, CEO Jeffrey Katzenberg acknowledged the company's failing movies. In response, Katzenberg said the studio will start to rely on more sequels to its most successful franchises to help turn the studio around.

While the studios' latest sequel "How to Train Your Dragons 2" has made over $600 million worldwide, the film's opening weekend disappointed investors as it performed worse than the debuts of DWA's other sequels like "Shrek 2," "Madagascar 2," and "Madagascar 3."

Karasyov writes that the company's films continue to disappoint.

"We don't see a plausible argument for why HAS would pay 41% of its current market capitalization for a company which, according to its CEO is facing serious challenges," Karasyov writes. "Films profitability continues to decline and the ramp in consumer product revenue the bulls hoped for isn't coming: the revenue stream is down 21% so far in 2014."

2. Consumer product revenue is coming from smaller DWA franchises

Instead of customers latching on to products of some of DWA's most beloved films including "Shrek," "Kung Fu Panda," "How to Train Your Dragon," and more recent hit, "The Croods," Karasyov writes the top three contributors for consumer product revenue in fiscal year 2013 were "Veggie Tales," "Where's Waldo," and "Noddy."

The latter is a long-cancelled TV series which ran on PBS for two seasons ending in 2000.

3. DreamWorks Animation's next movie looks like a bust

Karasyov writes that DWA's latest film, "Penguins of Madagascar," a spin-off of its popular "Madagascar" franchise out Nov. 26, doesn't look like it will be a hit either.

"Current industry estimates are well below the consensus US box office," says Karasyov. "The Street is expecting $185 mln; industry estimate are at $135 mln."

"The new release The Penguins of Madagscar, according to the company, [is] expected 'to generate approximately $8 million in total revenue by the end of 2017,'" Karasyov adds.

Analyst Eric Handler at KM Partners also wrote a report titled, "Multiple Reasons Why a DreamWorks Animation Acquisition Does Not Make Sense."

From the report via THR:

"There is no doubt that Hasbro wants to turn a number of its franchise properties into feature films, but its risk profile would substantially change entering into the volatile movie production business with a company that has not generated positive FCF [free cash flow] in several years and has had trouble making profitable animated films," he writes. "In addition, a business transformation of this magnitude could have negative implications for Hasbro in its relationship with Disney."

This isn't the first time DreamWorks Animation has tried to find a buyer. Japanese company SoftBank was in talks to acquire the company in September, according to The Hollywood Reporter.

Deadline also reports that, in a separate deal, DWA is in talks with Hearst to turn the company's purchase of YouTube content producer AwesomenessTV into a joint venture. DreamWorks Animation purchased AwesomenessTV in May 2013.

At this point, it looks like DreamWorks Animation just wants someone to swoop up the company.

"It appears that the management is actively looking for a buyer for the company so far (and we think ultimately) unsuccessfully," writes Karasyov. "In the meantime, the upcoming slate [of films from DWA] leaves little hope for improved performance."

We have reached out to Hasbro for comment and will update if we hear back.