Analyst: 2014 Box Office Starts Year on Solid Footing

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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities. 

Movie Rental Industry

Key Redbox releases this year (with domestic box office total from BoxOfficeMojo.com):

  • March 18: Frozen ($398 million), American Hustle ($150 million), Mandela: Long Walk to Freedom  ($8 million)
  • March 25: Gravity ($273 million), The Wolf of Wall Street ($117 million), Saving Mr. Banks ($83 million), Delivery Man ($31 million)
  • April 1: Anchorman 2: The Legend Continues ($127 million), 12 Years a Slave ($56 million)

Key Redbox releases last year (with domestic box office total from BoxOfficeMojo.com):

  • March 19: Argo ($136 million), Zero Dark Thirty ($96 million), Anna Karenina ($13 million)
  • March 26: Lincoln ($182 million), Killing Them Softly ($15 million), The Collection ($7 million), Chasing Mavericks ($6 million)
  • April 2: Red Dawn ($45 million)

Over the next two weeks, there are two rental releases that grossed more than $50 million in domestic box office, compared to three last year. DVD rentals for the upcoming two-week period should underperform the same period last year.

Last month, Outerwall (NASDAQ:OUTR) announced the final results of its modified Dutch Auction tender for $350 million of its common stock. The company accepted for purchase roughly 5.3 million shares at a purchase price of $70.07 per share for approximately $370.8 million. These shares represent approximately 20.6 percent of the company’s outstanding share count as of March 11. Following settlement, the company has roughly 20.39 million shares outstanding.

We expect the company to generate over $200 million in free cash flow in fiscal-year 2014 (close to $10 per share) and spend at least an additional $150 million repurchasing stock, further reducing share count. Outerwall has cut costs by $22 million and has curt ailed new venture spending, which should allow for solid profit growth in 2014. At its analyst event earlier this year, Outerwall reiterated its intention to invest in its ecoATM business, and to continue a limited investment in SAMPLEit ($1 samples in drug stores), with ecoATM accretive to earnings per share by the end of 2014.

Winter Olympics TV viewing may have cut into rental demand during the middle part of the quarter. First-quarter revenue guidance is modestly above last year’s level, implying a limited impact, and management did not comment on guidance at its analyst event earlier this year. At the midpoint, EPS guidance is below last year’s level, in part due to differences in amortization. However, EPS guidance does not take the $350 million share repurchase into account, and we expect Outerwall to have an average of 23.4 million shares outstanding for Q1, compared to 28.9 million last year, suggesting significant upside to guidance and consensus estimates.

Netflix (NASDAQ:NFLX) shares have declined recently from net neutrality and competition concerns. Netflix shares hit an all-time high of $458 last month, but the stock has since pulled back 25 percent. We believe that the recent share price decline is largely attributable to concerns over the impacts of net neutrality, which we believe are warranted, and concerns that the Apple-Comcast deal means that Apple will launch a competitive product, which we believe are unwarranted.

Regarding net neutrality, we think that charges by Internet service providers (ISPs) have the potential to meaningfully impact Netflix’s domestic streaming profits. As a result, we think that a price increase for Netflix’s streaming service is inevitable. Although content costs are clearly on the rise, we believe Netflix has done a masterful job of balancing quality against quantity, cutting out large portions of its streaming content in favor of a much smaller portfolio of higher-priced content.

The looming off-balance sheet streaming content obligations of roughly $7.3 billion (and growing) suggests to us that Netflix is delaying the impact of higher content costs on its income statement by pushing the costs into future periods. Longer-term, although it is far from certain that Amazon will offer a standalone streaming service, we believe it is far more likely that content costs will continue to rise with the expiration of every deal, and that ISPs will impose ever-increasing fees for access to the last mile.

Exhibitor Industry

First-quarter 2014 box office started the year on solid footing. January results were up 8.1 percent, led by Lone Survivor; February was up 13.4 percent, led by The LEGO Movie; and March was down 4.6 percent, led by 300: Rise of An Empire, with Q1 up roughly 5.4 percent.

We have updated our models for each exhibitor based upon box office figures. We are adjusting Q1 EPS estimates for Carmike (NASDAQ:CKEC) to 8 cents from 10 cents; for Regal (NYSE:RGC) to 3 cents from 18 cents (due to restructuring charges); for AMC to 10 cents from 5 cents; and for Cinemark (NYSE:CNK) to 26 cents from 24 cents to reflect Q1:13 box office results. We have adjusted our FY:14 EPS estimates for each company to reflect box office momentum into 2014 and the studios spreading out of the release slate with Captain America: The Winter Soldier kicking off summer action movies last week.

Michael Pachter is an analyst at Wedbush Securities. 

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