Imax Has a Collapse in Its Future

| About: IMAX Corporation (IMAX)
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If you are going to invest in a company, it better have a sustainable business model. That usually means the company's products fill an ongoing societal need, or they solve a major problem. Ideally, they are stocks you can hold onto forever. Otherwise, you may be caught in the trap of a fad stock. Of course, those that manage to catch the fad early on can enjoy a big run-up in price. They just need to be ready for the inevitable fall.

Some fad stocks include Jones Soda (NASDAQ:JSDA), Heely's (NASDAQ:HLYS) and Build-A-Bear Workshop (NYSE:BBW). There was nothing special about Jones. It was all about marketing, and it had to enter a market already dominated by companies like Coca-Cola (NYSE:KO) and Pepsi (NYSE:PEP). Heely's was just a shoe with wheels. Build-a-Bear is a nice idea, and while kids may always like stuffed animals, there isn't a sustainable model in building your own, especially considering the competition.

This finally brings me to a stock in the entertainment industry that is headed for a fall -- again. It already ran up big time in the late '90s, only to collapse to under $1 per share. I'm talking about IMAX Corporation (NYSE:IMAX). Hollywood box office admissions have been flat to down over the past 10 years, and are down YOY in 2011. To combat America's waning interest in the poor content being created, the studios are trying to lure audiences back in with new generations of gimmicks that they used in the 1950s, when television provided new competition to cinema. These gimmicks include 3-D and IMAX.

IMAX generates much of its revenue by leasing its systems to theatres and with maintenance and revenue-share contracts for remastering and distributing Hollywood releases in its proprietary format.

The problem is there are only so many movie theatres that can convert into IMAX theatres. The company has 528 systems in its network, of which only 348 are for commercial theatres, but says it may top-out at 1,300 screens. Most of the company's revenue backlog is generated by these orders. But there's a problem. The world of movie theatres is relatively finite. Sooner or later, every place that could have an IMAX screen system will have it. Then what?

IMAX can rely to a certain extent on rev-share deals with studios for remastering and distributing films in its format. But as indicated above, audiences are not going to keep spending extra admission money to see a movie in IMAX. The interest in the format will wane, prices will drop, and eventually studios will no longer see the advantage of spending extra coin on top of production and advertising expenses to convert films to IMAX.

Even worse, some installations aren't true IMAX. They are 25% the size of true IMAX screens, and patrons will eventually figure it out and there will be a backlash.

How is this actionable?

IMAX is a short. The challenge for investors looking to short the company is when to initiate that short. The key is to watch for:

  1. Company estimates on the total possible installed base of systems remaining static.
  2. Contract cancellations (two theatre chains make up 17% of their revenue).
  3. New gimmicks.
  4. Continued drop-off in volume of box office admissions, coupled with increased streaming numbers at companies like Netflix (NASDAQ:NFLX).
  5. Continuous quarters of cash flow decrease. We just started seeing decreasing cash flow in the trailing 12 months, from $29 MM in Q2 2010 to a $10MM negative cash flow in Q1 of this year.

My guess? Six months to a year from now, some of these symptoms will pop up. Aggressive investors may want to initiate a position now with tight stops.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.