Analyst: Movies and Entertainment Outlook a Mixed Bag

cinema

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 4: Dallas Buyers Club ($27 million), Baggage Claim ($22 million), About Time ($15 million), Oldboy ($2 million)
  • March 11: The Hunger Games: Catching Fire ($424 million), The Best Man Holiday ($71 million), The Counselor ($17 million)

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

  • March 5: The Twilight Saga: Breaking Dawn Part Two ($292 million), Wreck-It Ralph ($189 million), Playing for Keeps ($13 million)
  • March 12: Skyfall ($304 million), Rise of the Guardians ($103 million), The Man with The Iron Fists ($16 million), Cirque du Soleil ($13 million)

Over the next two weeks, there are five 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 outperform the same period last year.

Last week, Outerwall (NASDAQ:OUTR) announced the final results of its modified Dutch Auction self-tender offer 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 at 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 and spend another $150 million repurchasing stock, further reducing share count. Outerwall has cut costs by $22 million and has curtailed new venture spending, which should allow for solid profit growth in 2014. At its analyst event last month, 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.

The popularity of the Winter Olympics may have cut into rental demand during the middle part of the quarter. Management’s guidance for first-quarter revenue is modestly above last year’s level, implying that the impact will not be severe, and management did not comment on guidance at its analyst event last month. 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 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 more than two years ago. Netflix’s originals strategy has provided it with significant media exposure, and 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.

Last month, Netflix announced a multiyear interconnection agreement with Comcast to provide the broadband provider’s domestic customers with a high-quality Netflix video experience. While we believe that the amount to be paid by Netflix to Comcast is likely relatively small, we believe that in the aggregate, payments to Internet service providers (ISPs) will be quite large in the next several years. We observed Netflix TV advertisements during primetime at mid-quarter, suggesting subscriber additions may be tracking at the low end of company guidance.

Exhibitor industry

Q1:14 box office is starting off 2014 on a strong foot. January results were up 7.9 percent, led by Lone Survivor. February was up 13.3 percent, led by The Lego Movie. March is trending up 4 percent and Q1 is trending up 8.9 percent through March 16.

All of the companies in our movies and entertainment coverage universe have reported Q4:13 results. Regal (NYSE:RGC) and Cinemark (NYSE:CNK) came in below our expectations on both the top and bottom line on lower-than-expected attendance and Latin American headwinds, respectively, while AMC’s top-line and EBITDA results were roughly in line with our expectations, aided by the outperformance of IMAX’s dominance at the box office. IMAX (NYSE:IMAX) results were above our consensus expectations, driven by higher-than-expected DMR and JV revenues, which were lifted by Gravity. Carmike beat expectations driven by a family friendly slate driving attendance.

Michael Pachter is an analyst at Wedbush Securities. 

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