Newsletter: Winter Olympics Cut Into Retail Demand
Key Redbox releases this year (with domestic box office total in millions from www.boxofficemojo.com):
O 2/18: Machete Kills ($8)
O 2/25: Thor: The Dark World ($206), Nebraska ($17)
Key Redbox releases last year (with domestic box of fice total in millions from www.boxofficemojo.com):
O 2/19: Sinister ($48), End of Watch ($41), Fun Size ($9)
O 2/26: Silent Hill: Revelation 3D ($18), The Master ($16)
Over the next two weeks, there is one rental release that grossed over $50 million in domestic box off ice compared to four last year. DVD rentals for the upcoming two-week period should underperform the same period last year.
Outerwall (NASDAQ:OUTR) announced a share repurchase program that is expected to result in significant earnings accr etion 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 count.
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. At its analyst event last week, Outerwall reiterated its intention to invest in its ecoATM business, and to continue a limited investment in SAMPLEit ($1samples in drug stores), with ecoATM accretive to EPS by the end of 2014. Outerwall added $350 million of debt to fund share repurchases, moving to its target net leverage range of 1.75 – 2.25x net debt-to-core adjusted EBITDA in Q1:14.
The popularity of the Winter Olympics may have 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, and management did not comment on guidance at its analyst event last week. 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 have observed television advertising by Netflix at a higher-than-normal rate over the past week; advertising in the middle part of the quarter has historically suggested that subscriber additions are lagging the company’s plan.
We expected Q1:14 domestic box office to be up from easy Q1:13 comps of down 12 percent, but did not forecast how much higher it would be year-over-year. January results were up 7.9 percent, led by Lone Survivor. February was up 13.3 percent, led by The Lego Movie. Four movies (The Lego Movie, Ride Along, Lone Survivor, and Frozen) broke $100 million quarter to date, while only one was above that point last year, Identity Thief. Q1 is trending up 10.1 percent through March 2. We will likely revise our box office expectations for the quarter in March as the year has started off on a strong foot.
Except for Carmike (NASDAQ:CKEC), which reports on Tuesday, March 4, 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 (NYSE:IMAX) dominance at the box office. IMAX results were above our and consensus expectations driven by higher-than-expected DMR and JV revenues, which were lifted by Gravity
Michael Pachter is an analyst at Wedbush Securities.