Larry Meyers is at it again in his attempt to “refute” our refutation of his prediction for a collapse in Imax Corp.’s (NYSE:IMAX) shares and this time he made our work a little easier. In his latest article, Mr. Meyers lays out six reasons why he thinks the ‘recurring revenue’ argument doesn’t hold water. In our response, we will visit, and refute his points one by one.
1. “The math doesn’t add up.”
We couldn’t have said it better ourselves! Since we’re math people, and we don’t make an investment unless the numbers stack in our favor, we’re going to spend a little more time on this point relative to the other five. The author asserts that at IMAX’s maximum screen penetration of 1,250, the company would generate a maximum of $28 million in revenues from a $2.8 billion global box office success like Avatar. That does sound pretty bad, does it not? Well let’s do some real math here to find out a) just how accurate that $28 million number is; and b) if that’s not correct, what kind of number we actually expect to see.
IMAX makes box office money in two different ways—DMR and joint revenue sharing (JRS) arrangements. For DMR, IMAX takes approximately a 12.5% cut out of each and every ticket sold at IMAX theaters. With joint revenue sharing, IMAX signs an agreement with theaters through which the theater operator agrees to share a cut of the box office (approximately 20% for each theater) in exchange for hosting an IMAX screen. Knowing this, let’s now take a look at just how much money IMAX made from the release of Avatar itself.
Avatar was released during IMAX’s 2009 fourth quarter, on December 18. At the end of 2009, IMAX reported a total of 430 installed theaters, 117 of which were joint revenue sharing. Let’s back into some numbers here:
a) In the first quarter of 2010, IMAX generated $23.5 million in DMR revenue, $16.2 million of which came from Avatar (or 68.9% of the total). (Hollywood Reporter)
b) IMAX generated $29.3 million in box office revenue during Q1 2010. Using the conservative 68.9% DMR ratio above, IMAX generated approximately $20.2 million in JRS revenue from Avatar in the 1st quarter of 2010 alone.
c) With $200 million in global IMAX sales for Avatar (The Numbers), and DMR at 12.5% of the box office, IMAX grossed a total of $25 million in DMR from Avatar across its full run.
d) Given the above value from the DMR ratio in the 1st quarter, 64.8% of Avatar revenue for IMAX was received in the 1st quarter of 2010, with 35.2% received in the 4th Quarter of 2009.
e) Thus, total JRS revenue to IMAX from the Avatar box office was approximately $31.2 million.
f) With 117 total global JRS theaters in place at the end of 2009, that equates to CONSERVATIVELY (as not all the installs were open during the entirety of Avatar’s run) to $266,000 in revenue per theater reported to IMAX.
From this we know that IMAX made a combined total of $56.2 million in revenue from Avatar alone on its young, and growing installed base. That number dwarfs the $28 million Mr. Meyers suggests would be the maximum earnings on an Avatar-like blockbuster across a 1,250 theater network. Now let’s figure out how much the company would make on a blockbuster when its network reaches scale.
At the end of 2010, IMAX reported 518 total global theaters, 171 of which were JRS, or 33% of the total. Once IMAX hits 1,250 global theaters, and that 33% JRS rate is applied to a full network (that number is low given the guidance calls for near 50% JRS rate at the end of 2011), a movie like Avatar would have returned the company $110 million in total JRS box office revenue (412 JRS theaters at $266,000/theater). DMR revenue from a comparable release would be on the order of $58.1 million ($25 million / 430 theaters x 1,000 theatres, conservatively). Thus a comparable movie to Avatar would bring in approximately $168.1 million in total revenue to the company without much of a problem.
We acknowledge that Avatar is most certainly an anomaly, as blockbusters of that kind come around no more than once a decade; however, half of Avatar’s success is certainly within the realm of reason and that would result in approximately $84 million in revenue for IMAX just from one movie. All that can be said here is it appears that Mr. Meyers’ math is a bit off.
2. “The secular trend does not favor movie theaters.”
It’s irrefutable that movie theater ticket sales have been trending lower this past decade. The advent and proliferation of HDTV certainly played a large role in the decline of the theatergoer. But, in our opinion this also plays right into the hands of IMAX. IMAX screens are one-of-a-kind in size and depth, plus the audio is second-to-none. You need not watch a movie in 3D to benefit from the IMAX format. 3D is but an added benefit.
We also need to put movie theaters into the broader context of public forums of entertainment generally speaking. With tickets at sporting events, concerts and Broadway-style theaters running upwards of $40 per seat in many locations, people are being priced out of many forms of public entertainment. This is where IMAX fits in beautifully. While regular movies have become boring and stale and most would rather just watch them on HDTV from the comfort of their couch, even at a premium to regular tickets, IMAX is priced very favorably compared with all other forms of public entertainment.
Lastly, we need to consider overseas. While movies as entertainment are on the decline in the U.S., they are rapidly on the rise in places like China and India. IMAX recognizes this and has been aggressively expanding the international footprint (more on the international expansion below). Just in March, the company signed a 75 theater JRS arrangement in China, followed by an 8 theater deal in Russia and a 4 theater deal in India. (IMAX' China Investor CC Summary - pdf) .
3. “The quality of Hollywood content is bad, and getting worse.”
While Mr. Meyers' view is clearly noteworthy given his biographical background, and many would agree with his opinion, the problem is that quality is merely a subjective metric and there’s no reason to believe that there will be a permanent decline in objective measures of movie quality in perpetuity. Clearly not all movies fit neatly into the IMAX format. It’s one thing to watch a boring flick in IMAX. It’s another thing altogether to watch an action-packed thriller or a visually intensive fantasy movie. The problem with content for IMAX is not that it’s no good. Rather, content only now is being geared to maximize the utility of the format, and over time, the benefits will become increasingly more apparent.
We again would like to point readers’ attention to the international element. Just today was the second non-English release of an IMAX film in China—Beginning of the Great Revival. (Film Business Asia) This is a “big budget propaganda film timed to coincide with the 90th anniversary of the Communist Party of China.” Quality or not, that is the type of movie one would expect to succeed in China. This follows the record-breaking release of Aftershock in China last July. (Sound on Sight) Thus Hollywood is but a part of IMAX’ global product offering, and with the company’s global footprint expanding and deepening, more non-English productions are expected in the near-term.
4. “Box office cannot be predicted”
We all know this and that is a big part of why IMAX does not give forward guidance. However, one theater-goer says “I really love seeing movies in IMAX. The right movie plays exceptionally well…” and we believe many would agree (the quote is from Mr. Meyers himself). Movies certainly will come and go, the good with the bad, but so long as people believe that good movies are worth seeing in IMAX, and given the added benefit of time, IMAX will generate solid returns for shareholders.
5. “IMAX is a gimmick”
IMAX is not a gimmick, it’s a superior platform. Even Mr. Meyers “love[s] seeing movies in IMAX.” 3D may or may not be a gimmick (we would beg to differ when it’s done right), but IMAX is a platform, and as a platform it is winning an ever-increasing share of the overall box office take. Sales come down to quality, not gimmicks, as good 2D movies have outdrawn bad 3D ones in IMAX.
6. “Consumer behavior does not favor IMAX”
In order to avoid being redundant with points 2-5, we will steer clear from addressing content, pricing, or 3D here and focus on location, location, location. Mr. Meyers makes a big point out of the fact that “IMAX theaters are not right down the street in every multiplex,” and spells that out as a negative, when in fact that is a MAJOR positive. What that shows is that while at present consumers in rural areas may need to travel extra distances to get to a theater, IMAX has not even come close to its point of saturation. It’s impossible to both a) critique IMAX for having limited room to grow its network base; and b) critique IMAX for its theaters being too far to reach. In reality, we believe that the 1,250 maximum theater number will prove to be modest (bear in mind that just last year this number was 1,000) and that IMAX can continue to grow into the foreseeable future. At the end of 2010, IMAX had only 291 theaters in the entire US. That is far from a point of saturation.
“How is this actionable?”
By our modest estimates, IMAX can conceivably grow its theater network base by around 90 to 100 theaters per year for the next five years (please note that IMAX has guided for 115-125 installs in 2011). (IMAX Q1 2011 CC Supplement - pdf). This would take total theater installs to approximately 1,070 by 2016. Using our JRS and DMR numbers from above, and smoothing out average box office numbers, we estimate that IMAX can generate approximately $550 million in net income on the low end, and up to $1 billion in net income on the high end making largely conservative estimates about the mix of theater installs between JRS and lease-type arrangements. That means this company has the ability to grow its earnings by somewhere between 5.5 and 10 times its 2010 totals. With today’s forward P/E just under 20, it seems like a modest GARP opportunity, versus a business going in the wrong direction as Mr. Meyers would have us believe.
Disclosure: I am long IMAX.