Digital Domain hopes buyer interest isn't virtual

The company responsible for Tupac Shakur's holographic return to the stage and which plans to bring Elvis back into the building is being eyed by a plethora of strategic and financial acquirers.

Digital Domain Media Group Inc., a Port St. Lucie, Fla.-based digital film production company with five operating subsidiaries, officially went on the block on Aug. 18 when it hired Wells Fargo Securities LLC to advise on a strategic review. Although the company announced it had begun the review Aug. 1, it has been attracting interest since early in the first quarter.

"We announced on [the first-quarter earnings call] that we had been contacted by two large companies, strategic in nature, and we used that approach to formally tell the shareholders," Digital Domain CEO John Textor said in an interview.

Once the company came out with the Shakur hologram at the Coachella Valley Music Festival during the second quarter, however, "the pace of inbound interest ramped up," he added.

While he declined to name prospective suitors, Textor did say that there is a "specific strategic acquirer interested in every one of our businesses."

About one-third of the buyer interest is focused on the virtual performer business, in particular, and Digital Domain has entered into a number of nondisclosure agreements with various parties, he explained.

Even though the virtual performer division has yet to produce revenue, it "remains a big business opportunity for the company" and anyone who might buy it, Maxim Group LLC analyst John Tinker wrote in an Aug. 15 research note.

As a result, Digital Domain has been scooping up media and performance rights to various artists throughout the past two quarters, Textor said.

Most recently, on June 6, Digital Domain announced an exclusive agreement with Core Media Group, a portfolio company of Apollo Global Management LLC, to develop the Elvis Presley virtual performer for a show in Las Vegas.

"The possibility of developing other performers such as Michael Jackson and Jerry Garcia is especially attractive because, similar to animation, you do not have to worry about temperamental, expensive performers who can fall ill," Tinker wrote.

Digital Domain, which posted a $13.8 million net loss for the quarter ended June 30 on revenue of $33 million, isn't expected to generate positive Ebitda until 2013.

Founded in 1993, Digital Domain has a number of operating subsidiaries and joint ventures. In addition to the virtual performer segment, the company boasts a large Pixar-like animation studio called Tradition Studios, a digital advertising subsidiary called Mothership and a 3-D animation studio called Stereo Group. The company has done work on various commercials and feature films, including Tim Burton's "Alice in Wonderland" and "Transformers: Dark of the Moon," among others.

In addition, on Aug. 22, Digital Domain's wholly owned digital entertainment school, Digital Domain Institute, welcomed the inaugural class in its for-profit endeavor with Florida State University's College of Motion Picture Arts. The school offers graduates a Bachelor of Fine Arts degree from FSU as well as certificates in technical and professional proficiency from DDI. The company is also in the midst of setting up production studios in Abu Dhabi and China.

While the company's diverse tapestry of businesses bodes well for intercompany collaboration, it nonetheless confuses investors much like old-line conglomerates once did.

Tinker, who had a $9 stock price target on the company prior to the release of second-quarter results, has since downgraded the company's stock, which trades on the New York Stock Exchange under the symbol DDMG, from buy to hold.

"We believe in the huge business opportunities that new initiatives such as the virtual performer business and the education business provide," Tinker wrote in the Aug. 15 report.

"However, given the uncertainty in execution and timing of monetization of these efforts ... we recommend investors move to the sidelines."

Textor pointed out that it was just a year ago, in August 2011, that Digital Domain issued private shares for $9.63 apiece.

At that price, based on 43.56 million shares outstanding, the company would be worth roughly $419 million today. And on May 1, just two weeks after Tupac's April 15 virtual return to the stage, the company's stock hit a 52-week-high of $9.20 per share.

But since then, with the release of quarterly results, the stock closed at $3.15 per share on Tuesday, giving Digital Domain a market capitalization of just $146 million.

Textor sees much more value there, stressing that the company's parts are more lucrative than Digital Domain as a whole.

"The reality is that, if you sit down with an educational investor, you can see what is special about our university," Textor said. "The digital animation business -- that is very valuable to strategics that understand filmmaking. And a lot of studios are looking for partners with animation studios."

While negotiations have slowed, Textor is confident the company will have a whole new round of buyer interest come September.

"Things have sort of slowed down in the past few weeks with the August lulls, but we expect things to really pick up after Labor Day," he said.