Marvel Entertainment: Super Hero Stock?

The movie Iron Man tells the story of Tony Stark, a wealthy industrialist who is gravely wounded in an explosion, then kidnapped and held in captivity, where he creates a powerful armor. Eventually, Stark escapes, returns to the U.S. and begins a new life as superhero dedicated to fighting crime.

The history of Marvel Entertainment Group isn't all that different. It's the story of an old-line company that suffers in a comic book collectibles storm, then collapses into bankruptcy, where it rebuilds powerful brands before emerging. Returning to Wall Street, Marvel begins a new life as a super-volatile stock, dedicated to fighting skeptics.

Stark, a hero not without significant flaws who is played smartly by the unconventional Robert Downey Jr., has clearly won over America. Iron Man earned $102 million at the box office during the first weekend of May -- a non-sequel opening second only to Spider-Man, the tale of another Marvel superhero that grossed nearly $115 million when it debuted in 2002.

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Meanwhile, Marvel has won over investors. On May 5, the company added to the good news of Iron Man's box office with a report of first-quarter earnings that beat what analysts were expecting. Marvel also said that profits for all of 2008 would be slightly higher than what the company had previously indicated.

The stock jumped more than 9% on May 5 and is now trading near its highest price since the company emerged from bankruptcy in 1998. The shares (symbol MVL) closed at $34.32 on May 13.

But here's why investors might yet be tempted by that high-flying Marvel stock: Iron Man represents the dawn of a new era at Marvel, one in which it produces its own movies in-house, instead of farming them out to other studios for a licensing fee. The difference in profit potential is like the difference between a 99-pound weakling and a superhero.

To give you an idea, consider that the Spider-Man movies, produced by Sony Pictures, typically deliver $15 million to $25 million in box-office revenues to Marvel, plus a bit more in DVD sales and TV licensing. Iron Man, over the course of the film's revenue-generating life, roughly seven years, could deliver $300 million in revenues (including the take from DVDs and television), figures Stifel Nicolaus analyst Drew Crum. That, he says, would translate into earnings of roughly $1.10 per share. "That's meaningful, and that's only one of several films slated over the next few years," says Crum.

What's more, under the old model, Marvel would have to fork over 15% to 25% of its share of merchandising sales to its studio partners. Now, Marvel can keep every T-shirt, toy or trading card tie-in to itself.

And Iron Man's no fluke. The average box office take for previous PG- and PG13-rated films involving Marvel characters has been north of $200 million. Next up from Marvel's studio: The Incredible Hulk, to be released in June; followed by Iron Man 2 and Thor, due out in 2010; and Captain America and The Avengers (a consortium of superheroes including Iron Man and Hulk), slated for 2011.

Yes, that means no Marvel-produced movie in 2009, but we'll still see a Wolverine movie from Fox, and one starring The Punisher from Lionsgate.

And don't forget that Marvel is still in the comic book business, which turns out to be among the most profitable in publishing, with operating profit margins of 40%. Marvel leads the comics industry with 40% of sales. Publishing accounted for about 26% of the company's 2007 revenues, which came in at $486 million. Toys accounted for 18%.

Licensing, including the use by hundreds of partners of Marvel characters in everything from films, television, video games and software to theme parks and greeting cards, provided 56% of sales. Over time, investors can expect film revenue to be the top contributor.

The bulls see earnings growing at a compound annualized rate approaching 20% through 2010. Analysts, on average, expect annualized earnings growth of 17.5% over the next five years. Despite the stock's recent run-up, it trades at just 19 times estimated 2008 earnings of $1.83 a share, not unreasonable given earnings-growth expectations.

But just like Tony Stark, the Marvel model isn't perfect. Earnings, and hence, the share price, may be more volatile than average, especially as the company moves deeper into movie making and given the vagaries of film production and box-office success.

Still, investors who watch the stock closely may spot a bargain in Marvel shares over the next few weeks. The pre-release buzz on The Incredible Hulk has been largely negative, with rumors of creative differences between Marvel and leading man Ed Norton, a general lack of promotion and bad memories of the last, undistinguished Hulk film, released in 2003.

Cowen & Co. analyst Doug Creutz thinks worries about the film are overblown, but adds that investors may be tempted to take profits in Marvel's stock ahead of the movie's debut, in mid-June. Creutz, who is bullish on Marvel long-term, says he'd view any pullback as an opportunity to buy the stock.