Does IMAX Have Big Screen Trouble in Little China?

On this episode of Industry Focus: Technology, host Dylan Lewis is joined by Fool.com contributor Danny Vena to discuss IMAX's (IMAX 0.12%) largest competitor in China and a recent government mandate it received.

A full transcript follows the video.

This video was recorded on Jan. 26, 2018.

Dylan Lewis: Danny, big tech trouble in China is fairly well documented. I think it gets a lot of press. You told me, though, about the battle for the big screen in China. This is a story that I was kind of surprised to hear.

Danny Vena: I was kind of surprised when I heard it. But if you step back and think about it for a moment, the propensity for the Chinese government to favor companies that originated in China is well documented, so it shouldn't be too much of a surprise if they should favor a hometown favorite. Now, you may have heard of IMAX. IMAX is one of the largest theater companies in the world. They create the giant premium big-screen format that a lot of folks go to movies and see their blockbusters on. IMAX already does business in China. They control about 68% of IMAX China. They spun off their Chinese screen business several years ago, in 2015. China is the second-largest market in the world in terms of box office, behind only the United States. It's also important to note that China has seen significant ticket sales growth over the last few years. Now, there's a company in China called the China Film Digital Giant Screen Company, which, if you were trying to do a really descriptive definition of what IMAX is, it would come out very similar to that.

Lewis: That company description almost sounds like a front. It's so vanilla in its description of what the company does that it practically sounds illegitimate. Not to say that it is. It's a very real giant screen company, and they are in the theater business. But, you know what I mean?

Vena: Oh, absolutely. That's why I mentioned it. Now, the government gave them a mandate to become the largest premium format brand in the country, and they believe they can overtake IMAX in ticket sales by 2019.

Lewis: And you have to imagine that a company that gets a government mandate from a government that is notoriously involved in the commerce in its country is probably going to be well on its path to achieving that.

Vena: That's not a bad assumption. And what they're doing to achieve that is pretty interesting. In fact, the chairman's quote was, "Our top priority is expansion, not profitability."

Lewis: That's kind of taking a page from Jeff Bezos right there.

Vena: That sounds pretty familiar, doesn't it? So, this company, the China Film Digital Giant Screen Company, they allow theater owners to keep a larger percentage of the ticket revenue than IMAX does. IMAX has several different ways that they deal with theater owners. Because putting in an IMAX system is a large cash outlay, big amount of capital up front, they will either let the theater owners pay for the system up front, or they have what they call a joint revenue-sharing arrangement, which is, they say, "We'll front you the theater, we'll put the projection system into your theater, and you can pay us back over time with a percentage of your ticket sales." This Chinese company charges just a flat fee for installation that's significantly lower than what the theater owner would pay for an IMAX system. But then, you get what you pay for.

Lewis: Danny, you follow IMAX quite a bit. Is this something that has you a little bit worried? You talked about how China is the world's second-largest market for the box-office behind only the United States, and they have a fairly major stake in IMAX China. Is this something that concerns you at all as an investor?

Vena: I would be foolish not to be concerned about it. So far, someone making a statement like that, in and of itself, is not enough to make me sell my IMAX shares. I am holding my shares. But, that's something that bears watching, because the Chinese government basically can do what it wants. It's their country. And If they wanted to promote this other company ahead of IMAX, if they wanted to tell their consumers that this is the big bad Western devil, it could cause problems. And the people going to see the movies might think twice about going against something that has tacit government approval.

Lewis: Yeah. And operationally, it can be a little bit easier to get favorable financing if you are the hometown team, so to speak.

Vena: Right. So, I'm not concerned about it yet, but I'm definitely watching it.

Lewis: I think this example is worth highlighting because, we think about these super-big multinationals that we read about all the time. This is an instance of a fairly big company, IMAX, in a market that matters quite a bit to them, but not necessarily one where you think that the Chinese government would be heavily involved. This is a story line that really caught me off guard, and kind of a good reminder that the Chinese government can really decide to support any business that they'd like to.

Vena: Right. Just to put this into perspective, it's a pretty sizable chunk of IMAX's box office. If you do a comparison, IMAX's domestic box office in its most recent quarter was $80 million in box office. The Greater China box office was $60 million, which was about 27% of the company's box office totals. Even if the state-backed China Film Digital Giant Screen Company was able to make small inroads there, it could definitely cost IMAX in terms of box office.