March 31, 2004 - 9:38am EST by
2004 2005
Price: 5.87 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 226 P/FCF
Net Debt (in $M): 0 EBIT 0 0
Borrow Cost: NA

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I think that IMAX is a short as the business model doesn’t make economic sense to exhibitors or studios, North America is saturated, and they will eventually saturate the emerging markets as well. Considering that they make the majority of their money from theater installations rather than a recurring revenue stream, the fall off in revenue I’m predicting will bankrupt the company in a few years. At 20x earnings that they will have to stretch to make, the stock isn’t even cheap. I see the stock falling dramatically in the next 12-18 months as it becomes clear that their new initiates won’t get enough traction to save the company.

IMAX installs large format cinema systems for theatre operators. In addition, to a large up front payment when they install a system ($1.5-8 million), they receive annual royalty and maintenance fees (10K-200K). They also distribute films and run a few theaters, but they earn little on these businesses. The company’s prime profit center is from the installation of IMAX systems, which consist of a projection system, sound system and a screen. The cinema operator does the rest (construction, seating, etc). In contrast, it costs about 300-400K for the corresponding equipment in a 35 mm theater, so this is extremely expensive.

The company’s history is selling these systems in the institutional market (museums, etc.) vs. the commercial market (for profit cinemas). Having largely saturated the institutional market, they are now targeting the commercial market for growth, as well as emerging markets. As long as a science center could line up a donor for the upfront costs, all they have to do thereafter is cover their cash costs. In contrast, a commercial operator needs to earn a ROI on their investment. This is a key observation in understanding why this has been successful (kind of) in the past and why this won’t be in the future. With the markets in North America and Europe saturated, how long will emerging market demand continue?

Historically IMAX content was its own proprietary standard. IMAX content could only be filmed and viewed on IMAX screens (which actually have different dimensions than 35mm). To succeed in the commercial market, the company needs to overcome a chicken and egg problem regarding content. There just isn’t enough content to get exhibitors to build screens and there isn’t enough screens to get more content. IMAX has two strategies to address this: a DMR conversion of 35 mm films to IMAX format and their new MPX theater system.

A DMR conversion takes a major movie that was filmed in 35mm and converts it to IMAX format. This is a fairly expensive proposition for the studios: about $5-6 million all in depending on the # of prints and marketing. For 3D CGI (animation) this cost is much higher, somewhere between $10-20 million. There is some uncertainty about this # as it’s never been done. PIXR, a 3D CGI leader, seems to think it’s toward the higher end of that range.

The MPX is just a lower end IMAX system at a new lower price. This may help them hit their install numbers, but at the expense of profitability.

The business model is flawed on three levels: 1) the economics to exhibitors is awful, 2) the economics to the studios is marginal and 3) there aren’t enough slots and films to reach their goals of 6 DMRs year.

Econ to the exhibitors: I’ve done a very detailed build up of unit economics, but in the interest of brevity (somewhat!), I’ll get you there with a high level model. The key unknown in building the unit economics for a single installation is the top line, expressed as revenue per screen per week. I am going to assume $25K/screen/week on average over the year, but you can play with this assumption.

Here’s some historical data, to show that this is reasonable. Matrix 3 averaged just under 20K/week during it’s 8 week run. It was a little bit of a disappointing box office, but still a big movie (9th biggest in 2003). They did 65K their first week, 38K the second and were down to 19K and falling week 3. Over Young Black Stallion’s 14 week run, they averaged 9K/week. This was a quiet movie going season and not that great of a movie (but due to lack of content, it was the best the exhibitors had to offer). NASCAR, the currently running IMAX release did 22K the first weekend, 29K the next week and is down to 22K the most recent week. The most recent Harry Potter comes out on IMAX June 4th, to be followed by Catwoman 8 weeks later. I could see Harry Potter doing 50K a week for it’s 8 weeks, but would guess that Catwoman would be like a NASCAR or a Matrix 3. All in, averaged through the year, I think 25K/week is a good number, which equates to $1.3 million. Add maybe 200K of concessions, which are very high margin.

On the cost side, they studio takes about half of the revenue and IMAX will have royalties and maintenance of 100-200K. Then there are the operating costs like rent, payroll, electricity, etc. To keep it simple, theatre operators have about 15% EBIT margins. Applying this to IMAX’s revenue gets you per screen EBIT of $225K.

The least expensive IMAX is a MPX where you convert two existing screens to an IMAX format. The incremental cost of this is around $2.5 million. To build a MPX from scratch would be closer to $4 million. This is nowhere near 20-25% pretax hurdle rates required by exhibitors.

Econ to the studios: For a non 3D CGI, the incremental costs will be around $5-6 million. Given the studios 50ish% take a simple breakeven would be $10-12million, but this doesn’t account for cannibalization as many IMAX viewers would have gone to 35mm, were the IMAX version not available. The degree on cannibalization should be a function of whether the movie is released on the same day in IMAX format (referred to as day and date) or whether it is releases with a delay of say 4 weeks like Matrix 2. I assume 50% cannibalization for day and date and 33% for a delayed release. Adjusting further for a lower 35mm ticket price, I get incremental profits to the studio of $2.7 million on a day and date movie that does $22 million in IMAX revenues and $0.7 million of a delayed release that does $14 million in IMAX….nothing spectacular here. For the record, those box office numbers would correspond to a very successful blockbuster like a Harry Potter. Matrix 3 did 10 million worldwide and Young Black Stallion did $8 million. (Note: that Warner Brothers is the only studio who’s been doing DMR’s with IMAX recently. They have significant power in these negotiations I’d presume)

Slots/Films: IMAX’s pitch to exhibitors is that they’ll have 6 DMRs a year. Giving each film an 8 week window, theoretically this is possible as there are 12 months in a year. This isn’t that likely as there are only 4 serious slots for the blockbuster movies that the studios can even break even on: early summer, later summer, thanksgiving and xmas. In addition there aren’t that many blockbusters a year. There were 6-7 films that grossed $200 million domestically over the last few years. Are they going to get them all? That’s unlikely, given that 1-3 of these each year are 3D CGI (too expensive) or too long (IMAX can only handle movies that are 2 ½ hrs long).

Quality of 2003 earnings weak: Of the $18 million of operating earnings reported in 2003, 9.6 million came from cancellation payments (this was only $1.4 million in 2000) and $4.7 million came from 1x factors such as reversing A/R reserves.

2004 guidance a stretch: The guidance for 2004 is very back end loaded, with a lot of the earnings coming in 3rd and 4th quarters. This seems unlikely given that the 3Q is usually a weak installation period because it’s the summer (highest season of the year) and the operators don’t want construction going on.

Be forewarned that the stock tends to rally into movie releases and Harry Potter should be the most successful DMR release yet.


2004 Earnings miss. More proof that their new business model isn't working.
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