Outlook: AMC, Netflix, and Outerwall Are on the Rise
Movie Rental Industry
Key Redbox releases this year (with domestic box of fice total in millions from www.boxofficemojo.com):
o 2/4: Free Birds ($55), Escape Plan ($25), Runner Runner ($19), Closed Circuit ($6)
O 2/11: Ender’s Game ($62), Riddick ($42), Carrie ($35), All Is Lost ($6)
Key Redbox releases last year (with domestic box of fice total in millions from www.boxofficemojo.com):
O 2/5: Flight ($94), Here Comes the Boom ($44), House at the End of the Street ($32), Alex Cross ($26), Hit and Run ($14)
O 2/12: Taken 2 ($140), Looper ($67), Perks of Being a Wallflower ($18), Won’t Back Down ($5)
Over the next two weeks, there is one rental release that grossed over $50 million in domestic box office compared to zero last year. DVD rentals for the upcoming two-week period should outperform the same period last year.
Outerwall (NASDAQ:OUTR) announced a share repurchase program that is expected to result in significant earnings accretion in 2014. The $350 million buyback is likely to reduce diluted shares outstanding to around 21 million from last year’s 28 million, or over 20 percent. We expect the company to generate over $200 million in free cash flow in FY:14 and spend another $150 million repurchasing stock, further reducing share ount. Outerwall has cut costs by $22 million and has curtailed new venture spending, which should allow for solid profit growth in 2014, notwithstanding guidance for declining year-over-year net income on higher revenues.
Outerwall will likely continue to invest in its ecoATM business, and continue with a limited investment in SAMPLEit ($1 samp les in drug stores.) We expect ecoATM to be accretive to EPS by the end of 2014. Outerwall added $350 million of new debt, primarily for share repurchases, allowing it to move to its previously announced target net leverage range of 1.75 – 2.25x net debt-to-core adjusted EBITDA in Q1:14.
It is possible that the popularity of the Winter Olympics may cut into rental demand during the middle part of the quarter. Management’s guidance for Q1 revenue is modestly above last year’s level, implying that the impact will not be severe. 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. We think Q1 upside from the share repurchase will serve as a catalyst for Outerwall shares.
We believe Netflix (NASDAQ:NFLX) provides a compelling service at an affordable price, and has done a phenomenal job of winning back the loyalty of its customers since its decision to split the business over two years ago. Netflix’s originals strategy has provided it with significant media exposure, and we think that the company has momentum on its side as it continues to add domestic subscribers at a phenomenal rate. We see some signs that overall content quality is declining, as Netflix has been forced to trade off quantity of content in favor of a smaller amount of higher-quality content, and note that some of its expensive deals for originals and for studio content may trigger an even greater escalation of costs in the future.
While we admire the company’s ability to manage its spending in order to sustain its profitability, we question whether it will be able to do so by consistently generating cash flow that is lower than net income. In our view, this is a sign that Netflix will see far lower profitability than many expect when its revenues rise. We think Netflix has built a great service, has loyal customers, and is sufficiently in control of its spending to allow profitability; we do not think that it will deliver the level of leverage that its current valuation suggests, and expect holders to be disappointed as earnings growth slows.
We expect Q1:14 domestic box office to be up from an easy Q1:13 comp of down 12 percent. January results were up 7.9 percent, led by Lone Survivor. Q4:13 roll-overs Frozen, American Hustle, and The Wolf of Wall Street were still over $1 million for weekend box office February 7 – 9. February is trending up 14.6 percent, led by The Lego Movie, while Q1 is trending up 10.3 percent through February 17.
We initiated coverage on AMC Entertainment (NYSE:AMC) last month. AMC is in the early innings of implementing initiatives to increase its concessions and admissions revenues through reinvestment in its current asset base, offering a high return on investment opportunity, in our view. AMC’s quality-over-quantity strategicroadmap should drive revenue growth beyond M&A.
We updated our models for each exhibitor last month based upon final Q4 box office figures. Q4:13 domestic box office ended up 0.8 percent year-over-year from a crowded release slate in December. The strength in December was been driven by a crowded release slate and a strong showing from November roll-overs The Hunger Games: Catching Fire and Frozen. Christmas had five wide-releases in 2013 compared to three in 2012, driving the last weekend up 8.5 percent.
Michael Pachter is an analyst at Wedbush Securities.