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I went to see a movie in IMAX (Nasdaq: IMAX ) , except it wasn't really in IMAX. I'd been duped. My theater and IMAX apparently agreed that by stretching the size of the screen to fill the whole wall and using an IMAX projector then, voila, I was watching the movie in IMAX. This is apparently not uncommon.
That's when it hit me: Size does matter, and something might be rotten in the projection booth.
IMAX is a fad ... a fad, I say!
I define a fad company as something that is not a sustainable business. Heelys is only going to sell so many wheeled shoes. Build-A-Bear can only sell so many stuffies, cute as they are.
Unless the company innovates, IMAX does not seem to me to be a sustainable business. IMAX makes most of its money by leasing its systems to theaters, with maintenance and revenue-share contracts for remastering and distributing Hollywood releases in its format. Once they run out of theaters to do this with, they are toast.
"Wait," you say. "Can't do novo IMAX theatres be built?" I say, no way. For that to happen, they must do the following:
- Encourage exhibitors to include an IMAX theater in any new complex construction. This is unlikely, as IMAX would have to get a significant number of new theaters developed to have a revenue impact. Unfortunately, exhibition is a mature industry, and the current U.S. trend is that theaters are closing.
- Expand a complex to make a custom IMAX theater, which is costly and unlikely.
- Consolidate two or more theaters to create an IMAX theater (ditto), or
- Make a fake IMAX theater, like I went to (Bad! See below).
Thus, there are only so many existing theaters that can convert into IMAX theaters. The company has 447 systems in its network and says it expects a worldwide footprint of only 1,250 screens. So what happens when the world is saturated with IMAX screens? No more equipment sales. That could be a huge problem, because about 22% of IMAX's H1 revenue of $128 million comes from equipment sales, and that 22% comprises 67% of the company's H1 net income.
You might argue that once all those screens get installed, IMAX's revenues will soar from ongoing revenue-share deals from remastering and distributing films in its format.
Not likely, in my opinion, because IMAX is just a fad. To compensate for content that audiences are losing interest in, studios and exhibitors have raised prices and relied on fads such as 3-D and IMAX to offset the past decade's trend of flat-to-lower admissions. We've seen this before. Exhibitors tried VistaVision, CinemaScope, Todd-AO, Sensurround, Percepto, Smell-O-Vision, and even 3-D. They all came and went. Today's 3-D and IMAX are just the modern versions of these unsustainable gimmicks.
And in case you're wondering if box office revenue has been goosed by the IMAX gimmick, fellow Fool Rick Munarriz says it himself, "Hollywood probably wouldn't have had a record year in box office receipts in 2009 if it wasn't for IMAX". When this fad runs its course, which it will, Hollywood will find another fad. That's when IMAX leases will stop being renewed, and there goes another 24% of revenue and 75% of net income, and all the cash flow that goes with
I don't like companies that rely on a totally random set of events for revenue. Since IMAX makes money from shared box office revenue, it is beholden to Hollywood to produce great content that is also suitable for IMAX. I don't have to tell you that Hollywood's content stinks. The MPAA reports that gross admissions are flat to down over the past 10 years. This secular trend is going to worsen. Home theater systems are becoming more amazing, 3-D TV is on the way, and companies like Netflix (Nasdaq: NFLX ) are providing viable alternatives to going to a theater.
But the real kicker was my fake IMAX experience. I discovered that these screens are only 25% the size of "true" IMAX screens. That these installations exist at all, and are not true IMAX, is a deception played upon the moviegoing public and investors. The company is diluting its own product in an effort to grow. Bad news to this investor.
So rewind back to that 1,250-screen footprint. How many of these will be true IMAX or the diluted product that harms the company's brand?
Finally, investors have been fooled by IMAX before. Back in 2000-2001, everyone believed that IMAX was going to -- well, I still don't know what everyone believed -- but when reality hit, the stock went from $25 to $1.
This is the end
There are two takeaways here. None of this means IMAX stock can't go higher. The beauty of fad stocks is that if you catch them on the upswing, you can do very well. However, sooner or later the music will stop, and you'll want to be short.
When is it time to short IMAX? I'd keep an eye on the backlog, which the company reports every quarter. Once that backlog starts to decline for a couple of quarters, then I'd pull the short trigger.
Otherwise, do yourself a favor. If you must invest in the movies, then do it with either a diversified media company like Walt Disney (NYSE: DIS ) or a company with a proven track record like DreamWorks Animation (NYSE: DWA ) .
Movies are timeless. Movie screens and projection systems ... not so much.