The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Movie Rental Industry
Key Redbox (NASDAQ:CSTR) releases this year (with domestic box office total in millions from www.boxofficemojo.com):
o 5/21: Gangster Squad ($46), Side Effects ($32), Parker ($18), The Last Stand ($12), Promised Land ($8), Stand up Guys ($3).
o 5/28: Broken City ($20), Dark Skies ($17).
Key Redbox releases last year (with domestic box office total in millions from www.boxofficemojo.com):
o 5/22: Contraband ($67), The Woman in Black ($54)
o 5/29: Man on a Ledge ($19), Gone ($12)
Over the next two weeks, there are five rental releases that grossed over $50 million in domestic box office compared to four last year. DVD rentals for the upcoming two-week period should outperform the same period last year.
Redbox should benefit from a very strong summer release schedule. There are 22 films with budgets greater than $100 million scheduled this summer, compared to 15 last year and an average of 12-15 most years. There are going to be several films that people want to see, but the crowding of the release schedule will make it impractical for them to see all of the movies they care about in theaters.
As a result, we believe that people are far more likely to rent the movies when released on DVD. The average time from theatrical release to DVD is under five months, and even for movies falling within the 28-day window around half of Coinstar’s supply, DVDs are generally available within six months of release. That means that the majority of big-budget films will be available in Q3 or Q4 for Coinstar, and Coinstar’s guidance implies that they understand this. As a reminder, the high end of CSTR’s guidance calls for Redbox revenue growth from $1 billion in the first half to $1.2 billion in the second half.
Netflix (NASDAQ:NFLX) believes it can grow its domestic footprint to 60-90 million households; with only 90 million households connected to the Internet, this implies 66-100% penetration and discount potential competition. Discussing its margin structure for domestic streaming, management stated its intention to grow revenues faster than content and marketing spending, suggesting growth at ever increasing profitability.
Both comments reinforce our view that the business model is broken. Only 85 million households in the U.S. pay for access to television currently, so it seems a stretch to presume that 70 percent (at the low end of Netflix’s goal) will add an additional pay layer from ANY provider, especially in light of increased competition from Redbox Instant by Verizon (NYSE:VZ), Amazon (NASDAQ:AMZN), Hulu (NASDAQ:CMCSA), and, most recently, content providers establishing their own services. Similarly, it seems illogical to presume that Netflix can grow its base by spending less on content per customer; the company appears convinced that it can add 100-200 percent to its domestic subscriber base, yet seems determined to grow content spending by less than this amount.
In our view, the content owners are interested in maximizing profits for their stakeholders, and are unlikely to allow this to occur. It is significant to note that free cash flow lagged net income by $119 million, suggesting a $2.00/share drain on EPS in future periods.
We expect Q2 domestic box office to end up 5 percent from a strong June. Q2 quarter-to-date box office is trending up 1.8 percent through June 2. April was down 12.1 percent and May was up 11.3 percent. June is expected to have several large blockbuster releases with Man of Steel, World War Z, and Monsters University. Fast & Furious 6 has already grossed over $100 million domestically in the last week of May and will likely add to June’s box office numbers.
We estimate that international admissions revenue will be up 6 percent in Q2. Q2 is trending down 4 percent in U.S. dollars y-o-y, however, we expect Man of Steel to outperform last year’s Madagascar 3 in Latin America.
We expect a very active M&A market to continue in 2013 and 2014 as the industry continues to consolidate. The transition to digital, IMAX (NYSE:IMAX), and 3D screens is helping to drive industry consolidation. Approximately 85 percent of screens have been converted to digital, and while most circuits have some portion of screens converted, a significant number (around 6,000) remain unconverted.
According to Carmike (NASDAQ:CKEC) there are approximately 40,000 screens in the US, of those, ≈ 20,000 are controlled by the top four exhibitors, ≈ 4,000 are controlled by the next 15 largest circuits, while the next 36 circuits control ≈ 3,600 screens, leaving over 12,000 screens owned by very small operators. Theaters coming to market fall into two buckets: (i) private equity owners, which are easier to predict due to their time horizon and (ii) family owned, which are harder to predict and usually come to market during generational transitions. Regal estimates that there are approximately 2,500-3,000 screens that are attractive to the big four exhibitors at the right price. Attractive screens are modern (built in stadium seating era) and in stable or growing markets.
Michael Pachter is an analyst at Wedbush Securities.
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