IMAX Corporation (NYSE:IMAX) is an entertainment technology firm widely known for its giant theater screens and, over the last three years, it has become the premier, immersive theatrical experience. By year end 2010, IMAX will have a network of almost 370 commercial screens in nearly 50 nations.
Investment Thesis: IMAX makes a compelling long opportunity due to the still largely unrecognized transformation of its business from primarily transactional to one with high-quality recurring revenue, strong operating leverage, improving mix shift, and a long runway for growth. The attractive economics, combined with a compelling value proposition for both exhibitors and studios, will allow IMAX to grow its screen count, and thus its revenue base, faster than expected.
Business Transition
IMAX is in the midst of a successful transition of their business from making documentaries and selling equipment to institutions to an entertainment company providing immersive, “big screen” Hollywood experiences. This new model will provide recurring revenue from sales of high quality systems to theaters and re-formatted digital content to movie studios. This transition will result in a highly scalable, high operating leverage business where incremental revenue flows efficiently through the income statement to the bottom line.
Growth Runway - Screen Count Growth & Available Content
IMAX’s screen count is rapidly increasing, as is the content available on IMAX screens. This year IMAX will grow from 288 screens to over 370, which is an increase of 28% YoY, with 200 additional screens in backlog. The company is planning for 85 installations in 2011, not including any agreements that are signed and installed intra-year (In 2010 agreements for 35 screens were signed and installed intra-year). The company believes the addressable market in the US is 450 screens, and 800 internationally, of which they will have about 240 and 130 respectively by year end. It is also worth noting these estimates have been growing steadily, and that available content (as measuring IMAX movies per year) has increased dramatically from 8 films in 2007 to 15 films in 2010. The increase in available content has come from studios proactively approaching the company to release their films in IMAX’s format.
Revenue per Screen -The Benefits (and Misunderstanding of) Mix Shift
Revenue per screen will be down the next year from $1.8 million to my estimate of about $1.4 million, because of the Avatar comp (which represented 28% of LTM Revenue) in the upcoming 4th and 1st quarters. It should be noted that the company guides analysts to model revenue/screen of $1.2m. This is the 2009 rev/screen number, which ignores the increase in screen utilization due to more available content (15 in 2010 vs. 13 in 2009). Revenue/screen should rise in future years as IMAX’s mix shifts more heavily toward international screens. Currently, international screens generate 50% greater revenue per screen, but currently account for less than 40% of IMAX’s revenues. Since the beginning of 2009, international screens have represented 110 of the roughly 135 screens installed.
Unit Economics: IMAX generates revenue from exhibitors and studios. It charges studios a percentage of their box-office take shown on IMAX’s screens. The company sources revenue from one of two arrangements with exhibitors: a sales-lease arrangement, where equipment is sold and a small percentage of exhibitor’s revenue is collected, or a joint-venture, where IMAX installs its system for free in exchange for 20% of the exhibitor’s box office revenue on that screen. The average revenue per screen is equal for DMR and JV revenue because studios and exhibitors typically split box office revenues 50%.
DMR Revenue from Studios
IMAX generates revenue for re-mastering Hollywood movies for its systems. This process costs IMAX roughly $1.5million per film and can be spread over all installed screens, resulting in a 12.5% royalty fee per screens.
Sales-Lease Arrangement
Historically IMAX has sold its systems into theaters for roughly $1.3 million with a cost of goods sold of $500,000. It also gets a small percentage (undisclosed) of the exhibitor’s box-office revenue.
Joint-Venture
Under a Joint-Venture model, IMAX bears the cost of a system and capitalizes it over the life of the agreement (which is roughly 10 years). This results in roughly $50,000 in annual depreciation expense per JV Screen. In exchange for this, IMAX takes a substantially larger percentage of the exhibitor’s box-office proceeds.
Some cash-strapped theater owners have been gravitating toward this arrangement because it allows them to install an IMAX without the large capital expense.
Value Proposition: IMAX presents a compelling value proposition to everyone in the value chain.
To Exhibitors: IMAX has a great deal to offer a theater owner. First, it offers an immersive experience that customers want, one that can’t be replicated in the home. Second, IMAX allows exhibitors to charge a premium for this experience, roughly 30% on average. It is also worth noting that discussions with exhibitors indicate that an IMAX theater has a signaling effect to the public, that a given theater is “high-quality”. This then improves ticket sales across the board at that theater, not just for IMAX films. Increased traffic drives concession sales, which are an important driver of theater profitability at 90% gross margins. It was also revealed in those discussions that exhibitors have noticed “dropping an IMAX” in a theater creates a protective moat around that theater, and no competitor will build a theater nearby. All of this suggests willingness on the part of theaters to “arm up” and install an IMAX theater as soon as possible.
To Studios: Re-mastering a film in IMAX sends an immediate signal to the public that this is not just a movie, but an event, something the public must see. Each and every one of the last 22 movies shown in IMAX have opened the box-office weekend as the #1 film. Studios appreciate that IMAX tickets command a premium, but what they truly love is the fact that its drives more people to watch the movie in theaters. It is important for a film to be branded a “success,” which has trickle down effects for rentals, merchandise, and sequels. This is illustrated both by the increase in available films IMAX now can choose from (40-45 this year alone, according to the company).
Risks to the Thesis:
Damage of the IMAX brand: IMAX has spent 40 years building a brand in the mind of the public. This brand represents high-quality, immersing theatrical experiences. Anything that diminishes the brand would decrease both the public’s willingness to pay a premium to see a film, and the value proposition to the rest of the value chain.
3D Movies Become a Fad: This is possible, but IMAX is more than just a 3D slate. For example, the most recent Harry Potter movie was not released in 3D, but was released in IMAX.
Competition from Theaters Themselves: Major theater chains (AMC and Regal) are rolling out their versions of the big, immersive theater experience. However, it is worth noting that their own screens are for locations where they cannot get IMAX. Theater chains have a preference for IMAX, which is demonstrated by the rapid pace at which theaters are signing up and confirmed by conversations with the exhibitors.
Recession Slows Adoption: This could hurt theaters’ ability to spend the CapEx necessary for an IMAX screen. This is mitigated somewhat by the Joint-Venture agreements, but some theaters could be inclined to wait until conditions improve rather than give IMAX 20% of their box-office take.
Valuation:
I believe IMAX is undervalued for a number of reasons: lack of good or meaningful analyst coverage and poor estimates, the idea 3D is a fad, misunderstanding of the operating leverage inherent in the business, underestimating how fast the network will spread due to the strong value proposition to the rest of the industry, as well as too much focus on the Avatar comparable.
Currently, the stock trades at 23.2x 2011 consensus estimates of $1.10, and 20.5x the current 2012 earnings estimates of about $1.25. These may or may not be correct multiples, but the estimates are clearly too low due to the misunderstandings I mentioned. Analysts are focused on the Avatar comp, which represented 28% of LTM revenue, but are missing the rapid network expansion (28% in 2010, 27% in 2011, and 18%+ in 2012). After a detailed analysis of screen growth, revenue per screen, and the scalability of the business model, I believe the company can generate $1.30 in earnings in 2011 and upwards of $1.65 in 2012. A more modest 18x multiple on those 2012 earnings estimates would imply a $29.70 price target, the current market multiple 20.5x would imply a $33.82 price.
Furthermore, I believe that there is significant upside to my estimates due to: faster than expected network growth, better mix shift internationally, and some of the optionality that is inherent in the movie industry.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
