Shares of IMAX (NYSE:IMAX) are taking a beating following a negative article written here on Seeking Alpha. In the article, Larry Meyers argues that IMAX “has a collapse in its future.” Unfortunately, Mr. Meyers is mistaken in his understanding of the company to the extent that he is missing out on one of the cheapest and most sustainable growth stories in today’s stock market.
Mr. Meyers begins with the assertion that
If you are going to invest in a company, it better have a sustainable business model.
That is a very astute observation, to which we would add a second categorical imperative: if you are going to invest in a growth company, it better have a scalable business model. Fads are neither sustainable, nor scalable. They have a finite maximum capacity and timespan and ultimately are due for collapse. In this day and age, people are constantly looking for the next fad to short.
Fads stocks cited include Jones Soda (OTCQB:JSDA), Heely’s (NASDAQ:HLYS) and Build-A-Bear Workshops (NYSE:BBW), and we would most certainly add Crocs (NASDAQ:CROX), perhaps the poster for fad stocks, to that list. It wasn’t too long ago that people were asking whether Netflix (NASDAQ:NFLX) was the next Crox, and in similar fashion, the bears were wrong because they did not understand Netflix’ business model. That’s understandable considering the fact that Netflix was in the middle of a pivot in how they ran their business, therefore clouding the picture. With IMAX the story is somewhat similar and many still clearly don’t get it.
The IMAX Story:
Three years ago, IMAX was an over-leveraged afterthought in the cinema business. The company had little going for it and was staring at a pile of debt. That all changed with the company’s decision to pivot their business model in two key ways: first, IMAX started soliciting major motion pictures for premium showings in their proprietary format (and please note, many successful pictures were 2D, not 3D); second, IMAX created a new joint revenue sharing structure through which the company would “license” their IMAX technology to theater chains in exchange for recurring revenues from the sale of tickets over time and pre-signed maintenance agreements giving IMAX rights to service the theater chains’ projection infrastructure.
In the middle of this transition, a major catalyst in the form of Avatar emerged, where visionary director, James Cameron, developed a whole new way to film movies in 3D. The success of Avatar generated enough cash to allow IMAX to repay the majority of its debt, taking the company from a negative enterprise value to a net-positive cash balance. This allowed the company to use its newly minted cash to invest strategically in growth.
Meyers' article asserts that IMAX “ran up big time in the late ‘90s only to collapse to under $1 per share,” but what the author misses is that the IMAX of the late ‘90s is an entirely different company than it is today, resulting in a misleading comparison. Also during that time, a major change ensued in home entertainment. In the 1990s, the average American home had big box TVs, and few had surround sound, while today, HDTV is nearly ubiquitous and many now have surround sound. The contrast between in-home movie viewing and the theater experience narrowed substantially, to the point where it has become far more beneficial for the average person to watch movies from the comfort of their own couch rather than at a theater. IMAX as a platform changes that entirely. Surely 3D is part of the draw at IMAX theaters; however, people are even willing to pay the premium prices for 2D movies as well and that has everything to do with the quality and size of IMAX screens—an experience unobtainable anywhere else.
How IMAX Makes Money:
The biggest point missed here is in understanding how IMAX makes money. To that end, there are several assertions that are simply incomplete, and in one case, incorrect. The company does make money from leasing arrangements, however, its growth has been fueled far more by the expansion of the aforementioned joint revenue sharing arrangement with theater chains, and DMR revenues for the conversion of films to the IMAX format. The real important point here is that the company has transitioned from realizing one-time revenues on a new theater install, to generating a stable and growing base of recurring revenues from each and every theater.
Secondarily, there is no “revenue backlog”, as alluded to by the author. The company has a theater backlog, in which they breakdown the number of joint revenue sharing vs. leasing arrangements. What’s most important about the actual theater backlog is that it keeps growing, it’s expanding internationally to regions where IMAX generates superior revenues per theater, and most importantly, it holds the power of even more future recurring revenues.
Not only do studios see the advantage in the new format, they are taking proactive steps to further participate and advance the IMAX advantage. Pretty soon studios will be doing two-stage releases whereby a movie is first released in IMAX and approximately one week later is brought to regular theaters. There has been some negative publicity of late about some underperforming movies in 3D, and what’s become clear is that movies converted to 3D after-the-fact tend to underperform, and movies in the RealD theaters do particularly poorly (in contrast to IMAX theaters).
Over time, these developments will help further entrench IMAX’s advantage, as studios are now gearing content to the format in two crucial ways: studios will now be filming movies using IMAX’s proprietary camera system, which enhances the picture (see Batman 3, which will be filmed in IMAX but not 3D, highlighting yet another strength of IMAX); and, studios are gaining more clarity on the kinds of movies that perform well on IMAX as time passes.
The company did experience a bit of a hiccup on the earnings side last quarter, as was anticipated. The first quarter is seasonally slow in the box office and there were few solid offerings. To someone who does not understand the IMAX business model, and believes revenues come via installation, the conclusion that the business is slowing and growth is unsustainable will sound intriguing.
However, since Mr. Meyers missed the shift to a greater share of revenues resulting from theater tickets, it’s also clear he doesn’t see the imminent upside. This quarter, and this summer, are a different story altogether at the box office. IMAX has several stellar releases under its belt of late, with the latest release of Pirates of the Caribbean, the newly opening Super 8, and the powerful franchises of Transformers and Harry Potter coming to its theaters this peak summer season.
IMAX today is in the early stages of a successful and ongoing transformation from a museum-based film company, to a broader and more attractive entertainment powerhouse. The company is well positioned, both in terms of its balance sheet and its target market, for steady and continued growth in the U.S. and abroad for at least the next five years.
Disclosure: I am long IMAX.