IMAX's Emerging-Market Twist

Tony Sagami

I was in my early 20s when VCRs became popular, and I remember thinking that the VCR would destroy the movie theater business. I reasoned who would pay $5 a person to watch a movie that you could rent for $3?

Boy, was I wrong. What I didn't realize is that people, especially teens and young adults, will always want to go out, and movies are one of the cheapest forms of entertainment around.

I figured out how wrong I was when I saw The Rolling Stones: Live At The Imax, a 1991 concert film of the group's Steel Wheels European tour that featured 15 of the group's most popular songs, including two of my favorites: Honky Tonk Women and Satisfaction.

This 1991 concert film was shot in the IMAX format and delivered unprecedented video and audio clarity when displayed on IMAX's enormous screens. I really felt like I had a front-row seat at a Rolling Stones concert.

I was hooked. I later took my children to see T-Rex: Back to the Cretaceous and Disney's Fantasia at an IMAX theater. The IMAX experience is unlike any other theater and a spectacular entertainment thrill.

What makes IMAX movies so lifelike is the company's proprietary technology that uses special cameras, special projectors, special film, wide screens, and specially-designed theatres with steeply raked seating.

IMAX technology uses the 70mm film, the largest commercial film format in motion picture history; which is 10 times the size of conventional 35mm, which you would see in a normal movie theatre.

A standard IMAX screen is 72 × 52.8 feet but can be larger. The world's largest cinema screen is in Sydney, Australia, and is approximately eight stories high at 117 × 96 feet. These giant screens extend beyond your peripheral vision, giving you the sense of being right in the action.

Okay, IMAX movies are cool, but what does it have to do with Asia? TONS!

The cinema culture is growing like crazy in China and rapidly becoming the main growth driver for IMAX.

FACT: China is adding new movie screens at the rate of four per day.

The Chinese love movies and are hitting movie theaters in droves. In 2010, the dollar take for movies grew by an awesome 64% to $1.5 billion. And that is on top of the 40% growth in 2009.

China now has more than 6,200 movie screens after adding about 1,500 last year. There is no sign of that growth slowing down as a number of Chinese players are racing to add theaters.

Many  small businesses are holding back until politicians settle their differences.

Hollywood experts expect China's box office receipts, currently the fourth largest in the world, to overtake Japan and India by the end of 2012. That will make China the No. 2 movie market in the world.

While still a long ways below the $11 billion of box office receipts in the United States plus Canada pulled in last year.

The Chinese movie market is expected to hit $7 billion by 2015 and may even pass the United States by the end of this decade. China should have 20,000 movie screens by 2020, which is more than triple the number that exist today.

A growing number of those four new movie screens each day will be IMAX screens and that means big opportunity from investing in IMAX stock.

Runaway Screen Growth. The key to success for IMAX is growing its footprint of movie screens. More screens = more money.

And yes, IMAX is rapidly growing its screen count. In 2010, IMAX increased the number of screens from 288 to 370, a 28% increase. Of those, 240 are in the United States/Canada and 130 are international.

IMAX plans on installing 85 more screens in 2011.

IMAX estimates the United States can accommodate 450 screens plus another 800 internationally. The process of growing from the current 370 movie screens to 1,250 is why you want to own IMAX.

Additionally, the number of new movies released in IMAX format is growing every year. In 2007, only seven films were produced in IMAX format, but that number grew to 15 films in 2010.

Deals, Deals, Deals. How is IMAX going to get to 1,250 movie theaters? By doing more deals like the three it signed in March.

Deal #1 in Russia: IMAX and Cinema Park, a Russian movie company, signed a deal to install eight IMAX systems in 2012 and 2013. These IMAX theaters will be located in Kaliningrad, Ulyanovsk, Omsk, Krasnoyarsk, Tula, Penza, Stavropol and Irkutsk.

This is in addition to the 10-screen deal that IMAX signed with Cinema Park in July 2010.

This new deal will bring the number of IMAX theaters in Russia and the Commonwealth of Independent States (CIS) to 46 by 2014. Russia and the CIS is IMAX's third-largest market, behind the United States and China.

The Russian IMAX theaters produce some of the highest per-screen box office averages in the world.

Deal #2 in India: IMAX and PVR Cinemas, India largest cinema operator, signed a deal for four IMAX screens in Mumbai and Bangalore. These three theaters will be in operation within the next 12 months. PVR currently has 142 screens in 18 Indian cities.

"There is a growing appetite for premium entertainment in India, and with the massive popularity of the IMAX brand worldwide, it has become very clear to us that now is the ideal time for us to enter into the IMAX business," said Ajay Bijli, Chairman of PVR. "IMAX is one of the world's most recognized premium entertainment brands and it fits perfectly with our mission to offer our guests the ultimate in movie-going experiences."

Deal #3 in China: Wanda Cinema, China's largest movie chain, agreed to open 75 new theaters under a joint revenue-sharing agreement. Wanda will become the largest operator of IMAX theaters outside of North America and the second-largest operator worldwide with a commitment of 91 theaters.

When completed, this deal will bring the number of IMAX theaters in China to 177. In 2011, 25 theaters are scheduled to be built and the remainder by the end of 2014.

IMAX expects its percentage of revenues coming from China to grow from the current 10% today to 25% within the next five years. "More than half of our revenue comes from the U.S., but we do think it's likely China will overtake the U.S. as the biggest market at some point in the future," said CEO Richard Gelfond.

Lastly, this deal puts the total backlog of IMAX theaters waiting to be constructed at 224, which is about three years worth of orders.

Multiple Income Stream. IMAX gets 'em coming and going. The company has five major income sources: IMAX system sales (33% of sales), film conversion (32% of sales), theater system maintenance (15% of sales), theater operations (13% of sales) and joint revenue sharing (4% of sales).

System sales and maintenance: IMAX has historically sold its proprietary movie systems to movie theaters, and these outright sales are still an important part of its business at 33% of sales. IMAX sells its systems to theaters for roughly $1.3 million with a cost of goods sold of $500,000 for a juicy 260% profit margin.

The sale is just the start of the gravy train though. IMAX continues to earns a significant stream of business (15% of sales) to maintain/service those systems.

Movie studio income: Movie studios pay IMAX to convert its film into IMAX format if they want to get played at IMAX theaters. That is especially true of films with complex graphics such as Avatar and Star Wars.

It costs IMAX roughly $1 million to $1.5 million to convert a film into its format. In exchange for converting the film, IMAX takes a percentage of the gross box office receipts, usually 10% to 15%. On a blockbuster film, such as Avatar, which grossed over $2 billion globally, IMAX makes a fortune.

Great interview with IMAX CEO Richard Gelfond that explains the impact of international expansion on IMAX prospects.

Watch the video on CNBC

The reason movie studios love IMAX is simple: IMAX puts more money in their pockets.

The trickle-down benefits for rentals, merchandise, and sequels is greatly enhanced by the IMAX brand.

Theater operations: IMAX owns and operates four theaters in the United States, and those four theaters are successful enough to contribute 13% of its revenues. That's a nice chunk of change but not the reason to own IMAX.

Joint revenue sharing: The reason to own IMAX is because of this last category which is currently the smallest division but the one that will become the most lucrative part of IMAX's future growth. IMAX installs its system for free in exchange for around 20% (terms vary by deal) of the exhibitor's box office AND CONCESSION revenues.

The advantage for movie theater operators, such as Regal Entertainment and Cinemark, to offer IMAX movies are overwhelming.

  • IMAX offers an immersive video/audio experience that can't be replicated in the home. Nothing matches the experience of an IMAX movie.
  • Movie operators get to charge a premium price — roughly 30% higher on average — for an IMAX movie.
  • Adding an IMAX theater has the effective of creating a competitive moat for movie operators because competitors are unwilling to build any nearby theaters.
  • Movie operators don't have to pay for the installation of any IMAX equipment as IMAX pays for 100% of the capital equipment.

However, the real beauty of this model for IMAX is that it has a fixed cost, and the payback, which is variable, grows as the theater network grows and more blockbusters hit IMAX screens.

As of January 31, 2011, the company had entered into joint revenue sharing arrangements for 230 systems. For big blockbuster films, that 20% translates into a mountain of money.

By the way, the new 75 theater Chinese deal is a joint venture, so IMAX will take a piece of the box office from both the studio and the theater in all 75 theaters.

Lastly, please keep in mind that I'm not suggesting that you rush out and buy IMAX stock tomorrow morning. As you know, timing is everything when it comes to investing, so you should do your own homework and decide for yourself when the right time to buy is but IMAX is a prime example of how a U.S. company can goose its sales and profits by making China a key part of its growth strategy.

Best wishes,

Tony

P.S. Want even MORE insight into harnessing the profit potential coming from the booming emerging-market economies? Check out my monthly Asia Stock Alert. I think it may be the best investment you'll ever make. Click here to learn more.


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Posted 07-15-2011 11:44 AM by Tony Sagami
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