Investment Idea #13
Investment Idea #13
Are people still going to the Big Screen?
The death of cinemas have been predicted time and again. While it might be true in certain geographies, the prediction, in this author’s opinion, has been by and large wrong. The chart below shows that it was wrong until 2002 and although tickets sold started dropping in the US and Canada (-c.25% over 17 years from 2002 to 2019), box office revenue did not and has kept growing.
Global box office revenue has continued to grow as ticket prices increased, like everything else thanks to inflation. China, India and the rest of the developing countries are also picking up hundreds of millions of movie goers and that further evidenced that the prediction has gone awry.
At the height of COVID-19, everyone believed that cinemas were never coming back. We can watch Netflix, along with so many other streaming services. Disney, the biggest producer of cinema worthy content like Star Wars and Avengers went all in with streaming. Most of the blockbusters are now available on Disney+, sometimes at the same time to movie hits the cinemas. Industry experts and analysts wondered if we will really see the Death of Hollywood.
I think we will not. The thesis is the same as a previously discussed name: Live Nation or LYV. Going to the movies is an experience, while we will go less, we want to go because it is memorable and we save that one movie we want to watch on the big screen and we bring the whole family along to create that experience. That is why box office has continued to grow.
The company we will discuss today is the right franchise for this investment thesis:
Simple financials (Dec 2023 estimate, USD)
Sales: 385mn
EBITDA: 125mn
Net income: 25mn
FCF: 50mn
Debt: 137mn, Mkt Cap 1.04bn
Financial Ratios
Estimated ROIC: 6% and ROE: 7%
EV/EBITDA 9.2x (Dec 24)
PER 18.9x (Dec 24)
Past margins: OPM 8-20%
FCF yield: 4.8%
While the numbers above do not project the attractiveness, the stock is interesting because it is a company that is selling intellectual property and the business economics scaling will be exponential as the cinema industry recovers and grows in the years ahead. Its core IP can also be sold into homes, non-cinematic venues, outdoor theatrical experience locations and theme parks, amongst other opportunities.
The company is IMAX Corp (ticker: IMAX), the iconic cinematic solution provider of premium theatre systems with eponymous brandname with a global theatre network of over 1,600 theatres in 87 countries. It started out in the 1960s providing its technology for museums and documentaries but then branched out to cinemas. The company also licenses the technology to allow producers to digitally remaster films into the IMAX format and now shooting entire movies in IMAX which enhances its brand and builds the foundation for further expansion into live and immersive events.
IMAX splits its businesses into three different segments: IMAX Technology Network, IMAX Technology Sales & Maintenance and Film Distribution & Post Production. The following shows the revenue and gross margin / profits for 2021 and 2022:
We can see IMAX’s healthy recovery from 2021 to 2022 with revenue growing 18% YoY and gross profits growing 16% YoY. IMAX has also routinely commented that it can grow its network from the current 1,600-1,700 cinemas and theatres to over 3,300 globally, implying a long runway ahead.
A quick introduction on the various business segments below:
IMAX Technology Network is the main segment generating majority of the gross profits for the company. Revenue is essentially a function of box office receipts (c.6-12% of box office sales) and will rise and fall with blockbuster titles and flops. The company publishes a list of titles annually and we know that there are close to c.70 titles of which c.30 are Hollywood movies like Avatar and Oppenheimer while the rest are titles in Chinese, Japanese and other local languages.
IMAX Technology Sales and Maintenance provides IMAX systems to cinemas and earn the upfront fee payment for the delivery and installation of their systems as well as annual payments. There are also hybrid revenue sharing arrangements and importantly, the recurring and stable maintenance business contributes to c.20% to overall gross profits.
Film Distribution & Post-Production and Others: These last segments make large format documentary films, provide post production and quality control services and also help incubate new businesses such as IMAX Live and IMAX Enhanced to go into outdoor events and homes respectively.
1. Fundamentals
Now that we have introduced the businesses, let’s discuss the investment thesis:
IMAX is the world’s premium and proprietary technology provider for cinemas / theatres to create quality immersive movie experiences for film lovers. It has built its brand since the 1960s working with leading directors and content creators to generate IMAX movies to further broaden global recognition. With the world recovering from COVID-19, IMAX rides on the secular tailwind of continuing box office revenue growth of blockbuster movies globally.
Its business model of taking a direct cut of box office ticket sales and charging for IP and technology allows for strong free cashflow generation with a significant portion coming from recurring sales and maintenance contracts. As its business expands, IMAX’s profits and margins should grow exponentially, generating supernormal returns for investors.
*IP = intellectual property
The following chart from its quarterly material surmises the thesis well:
ChatGPT generated content (with my edits) also provides insights on IMAX’s moats:
Premium Cinematic Experience: IMAX offers a premium cinematic experience to moviegoers through its large-format screens, state-of-the-art projection and sound systems, and immersive technologies. Cinema operators charge a small premium for a superior movie experience, and IMAX can capture this premium through its theatres.
Global Reach: IMAX has a global presence with theatres in numerous countries. Global demand for high-quality movie experiences will continue to grow, and IMAX can benefit from this trend by expanding its footprint into emerging markets and continuing to be a major player in established ones. Over time, IMAX believes it can grow its multiplex network to over 3,300 IMAX systems from the current 1,600+ systems today. This would mean IMAX increases its global share of theatres from current 3% to 6%.
Content Agreements: IMAX often partners with major studios to release blockbuster movies in its format. This helps drive foot traffic to its theatres and enhances its brand image. The investment thesis includes the idea that these content agreements will continue to provide a steady stream of popular movies, attracting audiences. More on this below.
Technological Innovation: IMAX continually invests in cutting-edge technology to improve the cinematic experience. This includes innovations like laser projection and VR experiences. Staying at the forefront of technology will give IMAX a competitive edge and keep customers engaged.
There are two positives layering on top of the fundamental thesis which is worth discussing further:
Positives
As discussed above, contrary to conventional wisdom, the global box office should continue to grow as it has done over the past decades at CAGR of c.5%. The chart below from IMAX shows the the box office receipts of US and Canada since 1979. The point is that Hollywood is resilient and has powered through all types of disruptions starting with VHS and DVDs. There is no reason why Netflix can bring down Hollywood when we look out long term ie 10-20 years. Going to the movies is experiential and memorable so we may watch less but we make every outing count even more.
Going forward, bulk of the growth will come from China and the other emerging markets going forward. Earlier this year, IMAX made the move to buy back the remaining listed 28.4% free float that it does not own for USD124m at c.50% premium. The premium sounds big but it’s a steal for IMAX because of the synergies alone could be c.USD20m annually.
China will fully open its economy in the next 12-18 months and IMAX stands to fully benefit from that. This deal also enables cost savings by streamlining of corporate structure and unlocking tax efficiencies. Unfortunately, the transaction will not go through as IMAX China’s shareholders voted in down.
The story was that IMAX listed its Chinese subsidiary in 2015 to better capture the growth in the Middle Kingdom but share price collapsed 80%, first due to lofty valuation being pulled back down by gravity around 2016-2019 and then COVID-19 did the share price in. As such, a significant number of shareholders could be in the red despite the 50% premium and hence voted the proposal down.
If IMAX Corp could fully consolidate its China business, it would capture all the growth of its most important market. But status quo is still good since IMAX owns more than 70% of IMAX China anyways. The next targets would be the other developing markets such as India and South East Asia,
The second positive for IMAX is how it has built and solidify its brand image with immersive cinematic experience with track record, collaboration with creators and partners. I first heard about IMAX about 30 years ago when their technology was used in the only omni-theatre at Singapore’s Science Centre and all primary school kids back then went and watch documentaries about the universe, faraway galaxies, stars, animals and nature.
Today, it has become this iconic technology used by famous directors like James Cameron and Christopher Nolan to make films and installed in theatres to deliver the best experience for movie-goers.
According to IMAX’s 10K, the following are the key differentiations:
Higher image and sound fidelity vs conventional cinema experience
Better contrast and brightness
Using proprietary theatre geometry that enables larger field of vision for the audience
Quality sound from specialized acoustics with reduction in background noise
To be honest, most movie-goers probably cannot tell the difference unless we watch in IMAX and then non-IMAX back-to-back but it feels good to know we are going to see this one movie this year in IMAX, we paid up a little, but hey, YOLO and if Christopher Nolan says it is good enough for him, then it is good enough for my family.
Having said all that, IMAX is a brand. The picture above shows how top directors swear by it and they are willing to lend their names to the technology. Avatar: Way of Water became to all time top grossing IMAX movie with USD250m in cumulative box office receipts and Oppenheimer the fourth best opening weekend delivering USD35m. IMAX takes a cut of this revenue and the 70+ IMAX films this year are expected to contribute the bulk of its USD385m sales.
Management
Richard Gelfond is Chief Executive Officer of IMAX Corporation and has been with the company for almost 30 years. Under his leadership, IMAX has evolved from a niche purveyor of nature and science documentaries to a Hollywood movie force. Gelfond, joined IMAX as co-chairman after his firm, Cheviot Capital Advisors, bought the company. He previously served as an investment banker in mergers and acquisitions with Drexel Burnham Lambert.
He has proven to be capable to lead IMAX to where it is today but his team is relatively new with most executives joining in the last few years. As such, key man risk exists for this company. IMAX may not compound as we think it could if Richard is not around. The mitigating factor is that at 68, he can probably do this for another 5-7 years, which may be good enough for our returns.
Risks
Apart from the key man risk, let’s look at a few other important ones:
China risk: China accounts for c.24% of revenue today and of the over 1,700 installed IMAX systems globally, China accounts for almost 800 installations and there are another 200 installations in the backlog. One customer, Wanda accounts for 22% of network and as such, should China or Wanda fail to grow revenue due to another lockdown or other idiosyncratic reasons such as ban on Hollywood movies, IMAX’s growth trajectory will go south. Needless to say, if Wanda faces financial troubles, IMAX will also be hit. The mitigating factor is that Chinese movie goers should come back now that the economy has opened up and IMAX has also proactively promoted Chinese films on top of Hollywood movies which will help cement its market position in the years to come.
Competition and brand maintenance: Hollywood has always been competitive and technology that supports the franchise is all the more so. IMAX has a niche but there are so many types of technology out there: Dolby and THX for sound, but Dolby has also encroached into vision. There is also VFX and cinema theatre operators themselves created their own system to compete.
As a testimony of how competitive the landscape really is, there are over 40,000 theatres in the US and Canada and yet IMAX only has a few hundred installations. As such, IMAX needs to continue to innovate to maintain its brand image. This requires hard work, ensuring theatres are well maintained, ensuring directors continue to want to use IMAX to make movies and constantly coming up with next generation improvements to keep the buzz alive. Gladly, IMAX has done this well, putting R&D dollars to work. For example, IMAX’s 70mm physical film for movie making has been transformative. The following shows a list of iconic and impressional blockbusters filmed with IMAX technology:
Star Wars: The Force Awakens
Batman v Superman
Dunkirk
First Man
Tenet
Wonder Woman 1984
No Time To Die
Oppenheimer
Source: Wikipedia
2. Technicals
IMAX is a volatile stock and we can see that its drawdown has been treacherous at 70-90%. The two drops in 2000 and then 2020 exemplifies this. At the height of the pandemic in 2020, IMAX’s share price fell from $22 to $10 in a few weeks. If you think that is bad, during the dotcom burst, it dropped from $25 to $3! This is a function of its small market cap at just c.USD1bn and we just have to be mindful that we should not bet the house on this name.
Looking at the price level long term, we have $40 at the peak around 2015-2016 and $10 at the pandemic low. So the risk reward looks okay from the pure technical perspective. But let’s also look at valuation.
3. Valuations
The usual table below shows earnings represented by Free Cashflow, EBITDA and Net Income. We tend ascribe respective multiples to derive the intrinsic values. IMAX’s valuations are tricky because it looks cheap when we use FCF and EV/EBITDA but not so if we look at PER. This is after we have added valuation premium from the average of its peers group. We added 1 turn for EV and 2 turns for PER and yet it is not screamingly cheap. FCF is also slightly lower compared to the industry average 5.6%.
The peer group is also tricky because there are no close peers and we are using cinema operators and content providers like Disney and Comcast. The market caps are also very different. Surprisingly, ROEs and ROICs of peers are not too high and combined with the cyclicality of the business, the market ascribes mediocre valuations to the industry.
Putting it altogether, I would use the average of the three intrinsic value and put IMAX’s target price at $22.5, implying c.20% upside. There is not enough margin of safety here but it would be a buy if it drops back to low teens. So do monitor the name and we would be providing timely updates should share price revisit those levels.
Huat Ah!
Main blog:
http://8percentpa.blogspot.com/
This post does not constitute investment advice and should not be deemed to be an offer to buy or sell or a solicitation of an offer to buy or sell any securities or other financial instruments.