Uncertainty Hangs Over DreamWorks

Investors in DreamWorks Animation SKG Inc. had reason to celebrate after the Glendale-based film studio announced better-than-expected second-quarter profit late Thursday.

But the champagne quickly ran out Friday. After months of declining share prices, the company’s financial results pushed DreamWorks’ stock up only 1.5% to $20.61 a share. Analysts and company executives expect the shares to continue to struggle over the coming weeks, regardless of how well DreamWorks performs.

Blame it on Paul Allen, the company’s largest shareholder. Under DreamWorks’ unusual ownership structure, Allen has the right to force the company to sell more than $300 million worth of shares to the public in the next three months, according to analyst estimates.

It stems from a corporate structure designed to make sure that DreamWorks’ original investors were paid back, including Microsoft Corp. billionaire Allen, who put up an estimated $707 million.

The possibility of such a sale has contributed to DreamWorks’ flagging stock, which hit a record low Thursday before the earnings report and is down 51% from its peak in 2004. Flooding the market with new shares would probably depress the stock even more.

“Our stock price has not caught up yet with our performance, and the possibility of a secondary offering is contributing to that,” DreamWorks Chief Executive Jeffrey Katzenberg said in an interview. “Anytime you have something like that hanging over a stock, it’s going to contribute to how investors see a company.”

However, the company would not say much more than that. When asked during its earnings conference call Thursday whether Allen had demanded the stock offering, DreamWorks President Lewis Coleman said: “We don’t believe that Paul’s request to trigger requires disclosure.... I cannot comment.”

Some analysts say that’s not what shareholders want to hear.

“It’s never a good thing when any executive says ‘we don’t think we have to answer you,’ ” said Anthony Valencia, who follows DreamWorks for money manager TCW Group. “It’s dangerous to create an impression that executives aren’t sharing bad news.”

By Friday morning, the analyst who probed Coleman about Allen’s intentions -- Richard Greenfield of Pali Research -- released a note suggesting that Allen had already informed DreamWorks that he intended to force the sale of 16 million of the estimated 50 million DreamWorks shares held by a holding company known as Holdco.

The company would not comment Friday on reports of Allen’s demands. A representative of Allen’s investing company, Vulcan Inc., refused to comment on Allen’s intentions.

But if such a sale were triggered by Allen, management would have to dissolve Holdco within 90 days, potentially making all 50 million shares available to the public, according to analyst estimates. That could more than double the number of DreamWorks shares on the market from the current 41 million.

Since June 1, Allen has had the right to dissolve Holdco and make new shares available to the public, a right that continues until December 2007, according to regulatory filings.

A source familiar with Allen and DreamWorks’ founders said it was inevitable that Allen would trigger the sale. Allen was one of the original investors in DreamWorks SKG when the company was formed in 1994 by director Stephen Spielberg, music mogul David Geffen and Katzenberg.

The source, a DreamWorks shareholder who requested anonymity because of the situation’s delicacy, speculated that DreamWorks’ founders were negotiating to privately buy out Allen, which would eliminate the need to sell shares to the public. Allen’s 15% stake in DreamWorks is worth $154 million. Additionally, analysts estimate he has rights to about 21 million shares in Holdco worth more than $420 million, including the 16 million that might be sold within the next three months.

If DreamWorks did privately buy out Allen’s Holdco stake, it could cost more than $500 million, sources say, because Allen would probably demand a premium for his Holdco shares. DreamWorks and its founders could cover the cost from the company’s private reserves and possibly through investments by directors such as Geffen.

Sources said relations between Allen and DreamWorks CEO Katzenberg and Geffen have been strained for at least two years. DreamWork’s managers “can’t wait to get rid of the guy,” one source said.

Vulcan has privately maintained that Allen made out handsomely on his DreamWorks’ investment, but would not provide details. Allen profited when DreamWorks SKG, the live-action film unit behind such movies as “Saving Private Ryan,” was sold to Viacom Inc.’s Paramount Pictures last year, and when DreamWorks Animation went public in 2004.

Today, analysts say, DreamWorks’ managers should say what is going on.

“There is no legal issue preventing them from disclosing if Allen has triggered a new stock offering,” Greenfield said. “It’s a yes or no question. I don’t know what the secret is. He either has or hasn’t.”