Good things come to those who wait, but better things come to those who are patient. On April 28th, Hazelton Capital Partners’ patience finally paid off as DreamWorks Animation (DWA) announced it would be sold to Comcast for $3.8 billion or $41/share. Waiting is a very passive activity, as one has little ability to shape the outcome. As a Chicago Cubs fan, I know all about waiting. On the other hand, patience is defined as one’s ability to tolerate a delay or an unfavorable outcome without getting upset. For a successful investor, patience is not only a virtue but a necessary discipline.

Hazelton Capital Partners began investing in DreamWorks Animation in April of 2012, and by Q1 of 2013, it had become one of our top five holdings. DreamWorks had many of the criteria we search for in an investment: It operated in a niche segment of its industry, it had a very strong, recognizable brand and a scarce resource, its growing 24 movie library, that would be very costly and difficult to replicate. Of course, there were a number of headwinds facing DWA and the movie industry: DreamWorks Animation was primarily a domestic brand and its North American box office and DVD revenues were in decline, competition for family viewing was increasing, and production costs were rising. But the biggest headwind for DreamWorks, unlike its competitors (Disney, Universal Studios, Fox, & Sony), was that its revenues and profitability was highly correlated to the two movies it released each year. DreamWorks Animation did not have a theme park, a cable station, or a successful merchandising segment that could offset softness at the box office, and so it historically traded at a discount to its book value.

Even with all the upfront challenges to its business model, Hazelton Capital Partners concluded that the company was undervalued. Our investing thesis believed that over time, DWA would deemphasize its reliance on the North American box office by building and monetizing its library and brand internationally, or find an interested buyer willing to pay a premium for an established library of franchise content. For animation studios, franchise content (aka sequels) is the elixir that drives their success. The characters are well known to both their audience and their animators. And each new movie release provides an opportunity to sell more merchandise. Since its release in 2001, Shrek has spawned three additional movie sequels, two holiday specials, and one spin-off (Puss in Boots).

At the time of our investment, DreamWorks already had three active movie franchises (Shrek, Madagascar, and Kung Fu Panda) that generated over $6 billion dollars at the box office, but whose value was not fully represented on the company’s balance sheet. Film studios use Ultimate Revenue Accounting to generate their financial statements. Initially, when a film is in production, the costs are capitalized on the balance sheet as inventory. When the film goes into release, the studio amortizes the production costs over a 10 year period by estimating the revenue the film will initially generate (box office, DVD & TV sales, merchandise, library, etc). By the fourth year, approximately 70-80% of the production costs have been removed from the balance sheet. Today, films like Shrek, Shrek 2, and Madagascar are no longer represented on DreamWorks’ balance sheet but will continue to generate money for the animation studio. With a strong film library of franchises, a studio’s library can produce a steady and growing stream of revenues with very high margins.

Soon after our initial purchases, DreamWorks Animation announced a licensing deal with Netflix for its current and future library of featured films which was rumored to be worth $30 million/film over a 5 year period. Not only did this deal help provide a valuation for DreamWorks’ expanding library of content, but it also furnished DreamWorks with the infrastructure to deliver its films into and beyond North America.

At the time of the deal, Netflix was primarily in North America, parts of South America, The United Kingdom, and Scandinavia. In 2013, the list of countries grew to over 75, including France, Germany, Spain and Latin America. By July of 2016, thanks to Netflix’s global expansion, DreamWorks’ content can be viewed by nearly 85 million people in over 190 countries. Not only did DWA not have to pay for its international footprint, but its licensing deal improved as the number of countries increased.

After a rapid 100% gain in share price to $35/share by the end of 2013, a precipitous decline in 2014 after a string of less than stellar box office performances, and two failed buyout offers from Softbank and Hasbro, DreamWorks Animation’s early 2015 share price was back to the levels not seen since 2012 when we first initiated our position.

During this period of time, DreamWorks worked to expand and improve its business model: It created Oriental DreamWorks, a Chinese joint venture movie studio and theme park in China, another deal with Netflix to create over 300 hours of original content based on its library of films and characters, and hired key executives in the areas of merchandising and branding. Understanding that DreamWorks Animation was worth significantly more than the value of its share price and coming to the realization that any buyout offer would not include him in a leadership role (rumors of why the previous buyout offers failed), Jeffrey Katzenberg, DreamWorks CEO, finally agreed to sell the company to Comcast for $41/share.

Over the four years that Hazelton Capital Partners invested in DreamWorks, even though our investing thesis did not change, we did not sit idly by waiting. In late 2013, after the rapid increase in DWA’s share price, Hazelton Capital Partners reduced its position only to repurchase those shares and more in early 2015. The Fund also used options opportunistically when volatility levels ran high. In total, Hazelton Capital Partners’ return on its investment in DreamWorks Animation was just over 180%.

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This article has been excerpted from a letter to partners of Hazelton Capital Partners.

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