The motion picture industry is not known for being innovative. The last disruptive technology to be introduced to this industry was talking movies during the 1920s. At the time, dialogue synchronized to the action on the screen was truly revolutionary. Since that time, innovation has been more evolutionary. In recent years, new digital technologies have enabled better viewer experiences and a whole new world for creators of animated movies. Special effects also create a new experience for the viewer. However, the basic function of recording real live actors reciting lines has not really changed all that much over the years.
In recent years, the most significant innovations focus on the audio and visual experience of the viewer. The new surround-sound audio systems coupled with expanded digital viewing offers an immersive an experience. The latest attempt at engaging the audience is the introduction of 3D. The stereoscopic effects of 3D are stunning but not exactly new or convenient to the viewer.
Dolby Laboratories, Inc. (DLB) is the company that brings us that marvelous surround-sound experience. Their audio products are found in a wide range of consumer electronics as well as in movie theaters. This San Francisco-based company is nearly 50 years old. Most recently, Microsoft (MSFT) chose Dolby to provide audio for Windows 8 for tablets and computers. This arrangement with Microsoft will actually extend to all PC makers that use Windows 8 and generate a royalty income for Dolby.
The consumer electronics market is in a state of transition from DVDs and PCs to media found on mobile devises, smartphones and tablets. For this reason, it is imperative for Dolby to forge partnerships for operating system vendors. However, Dolby is not leaving the movie theater market. They have introduced a new product at Atmos that is hyped as "our most revolutionary sound innovation." This new technology is purported to bring a more natural or realistic sound to the theater audience.
In 1Q12, EPS grew to $0.81 or 12.5% from the year ago $0.72. Revenues grew to $260.3 million or 4.1% from $250 million. For the twelve month period, EPS grew 5.4% to $2.74/share from $2.60/share. Revenues grew 0.6% to $956.5 million from $950.8 million. Expectations are for a decline in FY12 EPS to $2.61. Analyst estimates range from $2.56 to $2.65 and then start rising again in FY13 to$2.68. The company's growth rate has slowed significantly from its five year averages. The company carries no long term debt and holds 41,098.7 million in cash and short term investments.
Both gross and operating margins remain fairly stable or slightly expanding. The current gross margin is 89.8%, above the five year average of 87.82%. The average operating margin is 45.12% as compared to the current operating margin of 44.2%.
Profitability, as measured by ROE and ROIC look stable and healthy. They are also better than industry peer results.
The relative valuation ratios shown above suggest that Dolby is selling at a substantial premium to its industry median metrics. The company does not pay a dividend and its share buyback program has provided little value to the share price. By our calculation, FMV is about $33 or about 12.6X EPS E2012.
IMAX Corporation USA (IMAX) is the company that gives all new meaning to the expression, "going to the movies." The company specializes in creating cutting-edge awe-inspiring entertainment experiences. IMAX is a theatrical distribution platform and network with established markets in North America, Western Europe, and Japan and is expanding into the BRIC markets.
IMAX is taking steps to expand its footprint in the projection technology segment by acquiring numerous laser projection technology patents from Eastman Kodak. IMAX plans on introducing these laser-based technologies before the end of 2013. Laser technology is that which supports 3D. Laser projection systems can be used by IMAX to offer an enhanced projection system for traditional (non-IMAX) movie theaters. They will be both cheaper to operate and eliminate 3D royalty payments.
Revenues for the twelve months ending 1Q12 are $247 million vs. $221.1 million over the equivalent prior year period and $236.6 million in FY11. In 1Q12, revenues grew a strong 23% over the prior year period. On the year, EPS dropped to $0.28 from $1.08 Y-o-Y though in 1Q12 EPS is reported as $0.04 compared to ($0.02). TTM EPS-diluted of $0.28 beat FY11 EPS-diluted of $0.23 or 21.7%.
The company's gross margins are volatile and have ranged from 36.5% to 55.4%. The five year average is 44.8% close to the most recently reported GM of 48.3%. Operating margins are even worse. The five year average is about 3.36% and range from (15.7%) to 20.5%. OPM is now 13.6%. Volatile operating margins are indicative of a high degree of risk.
Profitability ratios such as ROE and ROIC, as shown above, are below five year averages. The company does not have excessive debt as a percentage of capital or of equity. However, the persistent history of negative free cash flow is an additional red flag. IMAX does not pay a dividend and carries $21.6 million in cash and short term investments on its books and $55 million in long term debt. This is another red flag. The share buybacks have not provided value to shareholders.
Though our valuation model suggests FMV at $27 per share, we consider IMAX to be a high risk investment with a poor risk/reward profile.
Our last company is RealD (RLD). RealD is the company that brings 3D technologies to the movie theater. Globally, RealD is the most widely used 3D cinema technology with more than 20,200 screens equipped with the company's technology. The company licenses its technology to movie theater operators and to manufacturers of consumer electronics.
There is some argument about whether 3D technology is a fad that is fast passing. Arguably, it was a novelty that may be wearing off quickly. To watch a 3D movie, audiences must wear special glasses just like in the 1950s. Some people, myself included, experience nausea and headaches from the stereoscopic technology. Additionally, 3D technology has been added to the television screens we use at home making the experience very commonplace. IMAX's new laser technology systems will give RealD a run for its money.
After several years of rapid growth, RLD's revenues hit $246.1 million in FY2011 and have not grown since. In FY2012, sales went to $246.6 million and TTM sales are at $246.6 million. The company lost money from 2008 through 2011. In FY2012, the company reported EPS-diluted of $0.65. Earnings estimates for FY2013 range from $0.30 to $0.71 and average $0.47. In FY2014, analysts estimate EPS of $0.31 to $0.90. As we see above, the PE ratios are very high and revenue growth does not suggest sustainable net income growth.
The company does not generate free cash. Its long term debt is $25 million and the company announced a new $125 million credit facility. Cash and short term investments total $24.9 million. There is no dividend and the company's share buyback program seems to destroy shareholder value. The company's history of losing money makes it difficult to compare recent operating results with the past.
Though some analysts estimate RLD's value to be in the low $20s, we think this is another highly speculative play.
As a final thought, I will suggest the movie theater business is becoming a buggy whip company. Why would I travel to a movie theater and pay an exorbitant price for admission when I can see a movie, in the comfort of my own home on equipment that rivals a theater's?