Ballantyne enjoys a roughly 70% market share of domestic analog projector sales and is positioning itself to leverage the digital transition as analog declines. The Company has a Master Re-seller licensing agreement with NEC, one of only three projector manufacturers licensed to produce digital projectors currently being deployed. In our view, BTN shares do not reflect a successful digital transition. With the shares trading at only about 10X expected 2008E EPS, 5.9X on EV/2007E EBITDA and BTN's roughly $1.39 per share in cash, we believe there is substantially more upside potential than downside risk at this level. We also view BTN as a potential takeover candidate for a larger player seeking to strengthen its own d-cinema position.
• Founded in 1932, Ballantyne has extensive experience and relationships within the domestic exhibitor industry, which it plans to leverage to capture a sizable share of the digital market as the world's 120,000 theater screens are upgraded to digital. Since there are only three digital projector manufacturers, we expect NEC – and therefore BTN – to gain solid market share.
• There are approximately 37,000 domestic screens, and the exhibition industry is highly concentrated. The top ten exhibitors represent an estimated 56+% of the total industry, and BTN has solid relationships with many of them.
• Moreover, international currently accounts for about 30% of BTN's total revenue, and we believe the Company will gain market share abroad, as well. The Company just acquired the NEC license for Hong Kong, and other offshore markets could follow, in our view.
• We estimate that BTN could garner at least 33% of the domestic and 25% share of the offshore markets. This could translate into revenue of more than $1.2 billion over the digital upgrade, with an estimated $90+ million of that in the form of recurring annual service fees.
• BTN is also assembling a service organization to support digital equipment. This could prove extremely important as: 1) it is high-margin and recurring ; and 2) digital equipment is much more sophisticated than analog and therefore more difficult to service internally.
• With $20 million in cash ($1.39/share), no long-term debt, and average cash from operations of $5.4 million per annum over the past two years, the Company has a solid balance sheet and is well-positioned to finance its transition. BTN believes it will continue to sell 800-1,000 analog projectors over the next few years, which should keep it cash-flow-positive as its digital business ramps up.
Investment Thesis and Valuation
We initiate coverage on the shares of Ballantyne of Omaha, which manufactures and distributes analog cinema projectors, enjoying a roughly 70% market share. This, the Company's primary business (92% of FY05's $54 million revenue), is expected to decline as exhibitors switch to digital projectors. To reposition itself, BTN is aggressively transitioning to digital. In May 2005, the Company signed a licensing agreement with NEC to sell NEC digital projectors. NEC is one of only three projector manufacturers licensed to produce digital projectors using Texas Instruments (TXN-Hold, Soleil/PrincetonTech Research) DLP (digital light projector) technology, which is currently the only commercially available digital projector technology. The worldwide installed screen base of roughly 120,000 is expected to transition to digital over the next several years. Since there are only three digital projector manufacturers, we expect NEC – and therefore BTN – to gain solid market share. Moreover, BTN will likely leverage its strong relationships with exhibitors, built through 70+ years as a vendor to the industry and a reputation for reliability and service, to develop a growing digital projector footprint.
At the same time, the Company is assembling a service organization to support digital equipment. The service aspect of the digital cinema transition could be extremely important to BTN, as: 1) it is high-margin and recurring; and 2) digital equipment is much more sophisticated than analog and therefore more difficult to service internally. We believe the combination of digital projector sales and recurring maintenance/service revenue could more than offset the expected decline in BTN's analog projector revenue as digital replaces analog over time and creates a growth opportunity for BTN. In our view, BTN shares do not reflect a successful digital transition.
With the shares trading at only about 10X expected 2008E EPS, 5.9X on EV/2007E EBITDA and BTN's roughly $1.39 per share in cash, we believe there is substantially more upside potential than downside risk for investors at this level. We also view BTN as a potential takeover candidate for a larger player involved in d-cinema, given its existing relationships with domestic exhibitors and growing service organization. We initiate coverage with a Buy rating on the shares and $7 price target, based on EV/EBITDA of 10X. While BTN has no publicly traded direct peers, shares of many other companies that supply equipment to the exhibitor industry trade well above this average (Figure 1).
The primary risk to our BTN price target, in our view, is that we are extremely early and the digital transition gains momentum later than we anticipate. However, given the lack of liquidity in the shares (average daily trading volume of only 16,000 over the past 3 months, according to Yahoo Finance) – and the Company's $1.39/share in cash, which we believe will support the stock price – we believe the shares could gain $1-$2 if the Company announces a sizable digital order in 2007-08. Other risks include the possibility that the two other digital projector brands, Christie Digital and Barco (BAR.BR-Brussels-not rated), gain market share at NEC/BTN's expense, that BTN spends much of its cash to fund its digital strategy, that as a licensor of NEC projectors, BTN has little control over pricing, that NEC assigns another license, or that another technology overtakes the TXN DLP technology NEC is licensing.
Ballantyne was founded in 1932 and has developed extensive relationships with major exhibitors over its 70+ year history. For example, BTN is a major provider of analog projectors to Regal Entertainment (RGC-Hold) and AMC Entertainment, the two largest exhibitors in the country. The Company distributes its products through over 100 domestic and international dealers and also through a small direct sales force. BTN has an installed base of over 50,000 motion picture projection systems, representing over 40% of the world's installed base. As a fully integrated equipment manufacturer, BTN can generally respond quickly and efficiently to customers' needs and enjoys a strong reputation among exhibitors.
In addition to projectors, lighting products and restaurant equipment contribute roughly 6% and 2%, respectively, of BTN's total revenue (Figure 2). Under the trademark Strong, BTN supplies spotlights for theaters and other venues. For example, BTN lights and searchlights are used at Walt Disney World, Universal Studios, various Olympic games, the Luxor and Stratosphere hotels in Las Vegas and other venues. BTN is seeking new lighting products to grow this profitable business. The Company also has a restaurant equipment business that is small but profitable.
The Company operates two production facilities: one at its headquarters in Omaha, Nebraska and another in Fisher, Illinois. BTN estimates that these plants are currently operating at about 30%-40% of capacity. Nevertheless, even at this level, BTN remains cash-flow-positive (the Company generated average cash of $5.4 million in both 2004 and 2005) and, at the same time, has been streamlining these facilities in anticipation of the digital transition. Ballantyne has also begun to sub-contract some of the parts for NEC, including projector pedestals. While small, this helps the Company amortize the cost of its plants and increases the synergies between NEC and Ballantyne, in our view.
Theatre Exhibition Industry Overview
Current Revenue Growth Constrained by Mere 2%-3% U.S. Screen Growth
The Company's projector business accounts for the lion's share of revenue. New projector sales come primarily from the construction of new theaters. Given the dramatic overbuilding that occurred in the late 1990s, the industry has become more conservative about expansion. The number of screens industry-wide grew by a CAGR of approximately 8% in 1996-1999, more than double the 1965-95 3.5% CAGR. The installed base reached a high of 36,448 in 1999 (Figure 3) before many major chains subsequently sought bankruptcy protection to close underperforming theaters. Now, the industry is only growing its screen base by about 2%-3% per annum. This, in turn, has constrained BTN's growth.
BTN has a clean balance sheet to support its transition to digital, as noted. The Company has $20 million in cash, no debt, and generated cash from operations of $5.3 million and $5.6 million in 2004 and 2005, respectively. The Company's capex has averaged about $800,000 per annum over the past three years, which it can fund from internally generated cash flow. Except for a potential acquisition, we believe BTN has enough cash to manage its transition to digital.
Recent Results and Outlook Ballantyne's operating results have only recently begun to be impacted by the pending digital transition. In 1H06, total revenue fell 5% year-over-year, primarily reflecting lower analog projector sales. The Company had cancellations for two orders in 1Q06, as the customer decided to pursue a digital initiative.
In 2Q06, BTN's net revenues declined 9% to $11.9 million, as theater equipment revenue fell 10% year-over-year, as exhibitors delay analog orders while they devise a digital timetable. As a result of the lower projector sales, BTN's 2Q06 gross margin fell to 23% versus 28.3% registered in 2Q05, reflecting lower production facility throughput. The Company's gross margin is tracking at 25% thus far in 2006 versus 27.7% registered in 2005. BTN's selling expenses rose 14.4% year-over-year, reflecting higher advertising and trade show expense in lighting and as BTN launches its digital initiative. To offset some of the expected added costs BTN likely will incur to launch digital, the Company is not accruing for bonuses this year. Mirroring the lower theater sales, BTN registered 2Q06 net income of $727,000 ($0.05 per share) versus $1.061 million ($0.08) recorded in 2Q05.
We believe BTN will register EPS of $0.23 in 2006, down $0.08 (26%) year-over-year. While 2007 is likely to be roughly flat with this year (we estimate EPS of $0.24), by 2008 the Company should begin to see the positive impact of digital. We believe that 2006 and 2007 could be trough years for BTN in terms of the impact of the digital transition. We estimate that BTN could grow EPS to $0.29 by 2008 and continue to grow EPS over the course of the digital transition.