Going to the movies is a fun activity, but Imax Corporation (IMAX) has established a new gold-standard for large screen films over the past decades, with its high resolution and fidelity sound. Its immersive experience for filmgoers has helped the company earn a niche spot in the vastly conventional cinema market and so far success was a no-brainer. In fact, the IMAX branded theatres generate a per-screen average of over $1 million gross, due to premium pricing and quality advantages. Since investment gurus Ron Baron (Trades, Portfolio) and Steven Cohen (Trades, Portfolio) bought the company’s shares last quarter, I decided to look a little deeper into this firm’s business model.
Expansion and Dependency
At the end of 2013, the market counted 837 IMAX theatres, operating in 53 countries across the globe. However, as a technology and brand licensing firm, the main stream of revenue derives from sales of equipment, maintenance services, and fees charged to cinemas for the conversion of films to its proprietary format. In general, the company collects a 10%-15% cut of the gross box office from cinemas with their systems, so as the theatre base grows, so does the royalty base, enhancing IMAX’s scale advantages. In fact, management recently declared that the new strategy would be focusing more on selling systems to theatres through a joint revenue-sharing basis. The goal of opening 1,700 new theatres over the next decade seems plausible, considering the 112 new installations arranged in 2013, which boosted the company’s system sales by 67% in Q4.
Furthermore, despite the longevity of the IMAX screening concept, its “wow” factor is stronger than ever, with popular directors like Christopher Nolan shooting parts of his movies with the firm’s proprietary 65-millimeter cameras. Not only does this trend differentiate the company from its peers Cinemark Holdings Inc. (CNK) and RealD (RLD), but it also creates a budding network effect. Also, while 2014 to 2017 are expected to be particularly good years for the firm, due to the highly anticipated blockbuster titles “Star Wars” and “Batman vs. Superman”, the company’s short term results tend to be volatile. As PSA depends on overall box-office results, revenue has been known to swing heftily between quarters and years. Nonetheless, quarter four showed very positive results, with per-screen box-office results up by 39% ($366,300).
Despite certain short-term volatility in IMAX’s balance sheet, the company benefits strongly from the low-cost distribution of the digital-format films to new theatres: as this base grows, so will the firm’s scale advantages. The cheap distribution system also gives the firm strong operating leverage, therefore, investors should expect the current 22.6% operating margins to hit the 35% mark by 2020. Moreover, the current returns on invested capital of 39.5% should stabilize at an average 30% over the next decade.
The moderate switching costs, consequence of IMAX’s multiyear contracts with exhibitors, can guarantee certain stability, especially in terms on revenue growth. Thus, the next decade should see 2013’s sluggish 3.9% growth jump to an annual average of 9.5%, with joint revenue-sharing agreements and DMR conversion fees accounting for nearly 70% of overall income. So, I feel bullish about this company’s long term future, although I do warn short term investors to abstain themselves from buying shares, as their current trading price premium of 132% relative to the industry average of 19.2x is most likely not worth the short term gain.
Disclosure: Patricio Kehoe hold no position in any stocks mentioned.