Sound investment: Gabelli Conference sees upbeat future for exhibition

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“Is this as good as it gets?” asks the Jan. 29, 2010 report on the U.S. box office, as prepared by investment advisor Gabelli & Company, Inc. (www.gabelli.com). “In short, no.”

Gabelli media/entertainment sector analyst Brett Harriss offers even more upbeat news about the cinema business: “While the industry has benefited from a blockbuster 2009 box office, we continue to recommend the exhibitors. We like the combination of low valuations, stable free cash flow and catalysts of 3D adoption and digital implementation.”

Regarding the latter two items, Harriss previously noted on Nov. 4 that they “have the ability to increase per-screen EBITDA [Earnings Before Interest, Taxes Depreciation and Amortization] of exhibitors by 5-10% in the near term and 10-20% over the longer term through higher ticket prices and increased movie attendance.” (**)

No wonder Harriss, who on March 11 once again organized and expertly guided his company’s second annual Digital Cinema & Movie Conference at the Harvard Club in Manhattan, opted to upgrade the name from the inaugural 2009 conference (http://bit.ly/Gabelli09). Rather than a mere “Movie Conference” reflecting the studio side alone, “the focus is on exhibition and, particularly, the transition to digital… This is the only exhibition-focused conference out there.” There were ten full company presentations (see our sidebar for a list of representatives), with Cineplex and Lionsgate attending for the first time, alongside numerous privately held companies, including AMC Entertainment and its CEO Gerry Lopez. “As a sales-side analyst,” Harriss notes, “our job is, one, to generate information and make recommendations, and two, to facilitate access to management.”

“Historically, the revenues and profits of exhibitors have been resilient in recessions,” the report noted, and theatrical viability was further evidenced by a 50% uptick in investor attendance, both during the presentations and in subsequent private one-on-one meetings. “The stocks have done well since we started recommending them,” Harriss explained during a post-conference review with Film Journal International. “And we think there is more to go.”

The key trends across all the presentations were that “the digital transition will happen” and that “3D is here to stay,” he observed. “Throughout 2008 and 2009, everybody was asking ‘Well, how big will 3D be?’ Now we have an answer with Avatar, Alice and huge percentages of total box-office revenues. Near-term, 3D offers a sustainable benefit of the transition to digital. After that, the longer-term opportunity is alternative content. The big picture is how exhibition can deploy digital to increase utilization of their box. A lot of their costs are fixed, so if attendance goes up, so do the profits.”

Given the record 2009 box-office and attendance figures announced by the MPAA (http://bit.ly/MPAA09stats), it should come as no surprise that the presenters too had nothing but positive things to announce. With the exception of The Marcus Corporation, perhaps, whose hotel side continued to face challenges in the current economy (http://bit.ly/MCSQ309). “We said, the lodging business has fallen out of the bed,” Greg Marcus joked only halfheartedly, “but you can’t fall off the floor. That’s the good news.” Truthfully, “the theatres have done very nicely” on the other hand. He cited the increase in operating 3D sites (http://bit.ly/3DNAMarcus); the pending completion of premium UltraScreen additions (“a very exciting product that makes the entire complex more attractive”); and, to secure a “greater share of wallet,” the company’s ongoing experimentation with more food and beverage options as well as restaurants (FJI January 2010). “We take care of our markets,” which offer “excellent coverage” at 100% market share in over 80% of their operating areas, and “with very well-built-out assets.” Pointing at the company’s 75th anniversary (“Three Generations/Two Businesses”), Marcus finds “many have come and gone, but we are still here. We are managing for the long term.”

Marcus Theatres’ digital rollout will be executed in large part with the help of Ballantyne Strong, who also presented at the conference before announcing its latest quarterly results on March 22 (http://bit.ly/BTNq409). Looking forward to the accelerating deployment, company head John Wilmers said, “Our busy d-cinema service group is getting even busier.” Having worked on integration and building the segment “for smooth flow of product and efficient installation” while financing was being arranged, “we are really stepping it up now.” Citing 70-plus years of experience in theatres and some 55 technicians on staff who are trained on all equipment, he assured attendees that Ballantyne is “sensitive to our exhibition customers’ needs.” When it comes to installation—350 to 450 screens per month at Regal, for instance—and ongoing maintenance, “the proof will be in the pudding.”

Cooking up a digital deployment since early 2006, Cinedigm Digital Cinema Corp. (see exclusive note from Bud Mayo in our sidebar below) and Carmike Cinemas have already refined the recipe. Circuit attendance was up 12.1% with “blockbuster numbers for the fourth quarter” leading to a 20.6% surge in box office (http://bit.ly/CKEC_q4fy2009). An 18.6% share of that is attributable to 3D admissions alone. For the full year, “3D accounted for approximately 17% of our box office,” Carmike’s Richard Hare attested. With over 95% of its circuit converted and 22% already 3D-enabled, with up to six screens per location (equal to 15% of all U.S. screens), Carmike CEO David Passman had ample reasons to laud the benefits. In addition to digital flexibility “virtually eliminating sell-outs,” Passman observed that “patrons who have the opportunity to see digital will start insisting on it.” Not to mention those who have come to experience it for the first time and expanded the market. As early-2009 3D titles, My Bloody Valentine and Coraline “over-indexed” at Carmike in comparison to the rest of the industry, Avatar has now become the “proof of concept.” About half of a 7.1% per-cap growth quarter-over-quarter was the result of 3D, as box-office increased from $6.45 to $6.91 per patron. Overall, Carmike had 52.7 million visitors in 2009 for an increase of 5.7%.

Hosting 240 million moviegoers annually, Regal Entertainment Group continues to be the industry leader in terms of revenue and adjusted EBITDA (http://bit.ly/REGq409), reported CEO Amy Miles. “It was a record year for Regal, with an average 200 3D screens throughout the year accounting for about 10% of total box-office take.” There has been no pushback from consumers regarding the premium pricing for either 3D or IMAX presentations. Instead, she sees “stability” and a “willingness to pay.” Regal’s 42 IMAX locations—with ten more to fill out the current agreement with the large-format provider—“are not just successful on their own terms, but are also incremental to the complex by making it more of an entertainment destination overall.”

With $660 million funding secured alongside its Digital Cinema Implementation Partners (DCIP), Cinemark and AMC Entertainment, just in time for the conference (http://bit.ly/DCIP031010), Miles confirmed Regal’s ambitious rollout to 1,600 to 1,800 digital screens by year end, of which 1,100 to 1,200 will feature 3D add-ons. The entire circuit should be retrofitted in three to four years’ time, she estimates, and at minimal cost to the exhibitor. “The last time that we grew as an industry was with stadium seating, but back then we paid for everything.” Miles lauded the support from the studios as “a significant investment into the theatrical side of the business,” just as she confirmed talks about a “measured approach” to evolving release windows. It is about “slightly shorter exceptions” in exchange for a more even distribution of bigger films throughout the year.

At Cinemark, and again thanks to DCIP, CFO Robert Copple anticipates an additional 600 screens for some 900 3D-capable theatres operating by year end out of 1,300 to 1,500 digital systems circuit-wide. “Yes, 3D is that big of a deal,” he intoned to investors. “Everybody knows it now… The lights have come on.”

That applies to alternative entertainment as well. With digital, “anything can be shown,” Copple notes. He sees a “growing opportunity for filling in times” at Cinemark that are not taken up by blockbusters. “Alternative content is the real big apple out there. The movie theatre could be very different five years from now,” he predicted. Another theatre changer could very well be the company’s own large-format development, Cinemark XD (http://bit.ly/CMKXD0310). Although a retrofit of an existing location can cost as much as $475,000 vs. about $100,000 for one that was planned from the start, Copple said results at the existing 16 XD locations have made the model work.

Lauded by the Gabelli report as its “favorite exhibitor,” Cinemark offers “international exposure, faster organic growth and attractive valuation.” (The latest numbers are at http://bit.ly/CMK_Q42009.) “We also recommend IMAX,” the analysts write, “due to its existing network, backlog-driven growth and its proven ability to secure blockbusters for its network.” The 2010 IMAX slate has indeed been finalized, the company’s Rich Gelfond confirmed. That includes more and more unique, special experiences, as was the case with The Dark Knight and will again be with the new Tron. By “consistently providing 20% of box office on 2% of screens,” he happily insisted that “consumers want IMAX and are willing to pay for it.” On the network front, after the successful implementation of its digital and joint-venture models (FJI May 2009), IMAX is now developing a portable system that inflates to something like a giant tennis ball. Gelfond envisions live events to happen there or applications in rural China, all the while “featuring the world’s biggest billboard on the outside.”

Speaking of big advertising, National CineMedia’s Kurt Hall reported that the latest quarterly results (http://bit.ly/NCM_Q4FY2009) once again “outperformed the marketplace,” with cinema advertising taking full advantage of “late money coming in” and “media dollars shifting to new media.” With the new digital equipment coming to its DCIP member- and owner circuits, Hall looks forward to improved 2K and 4K quality—with seamless integration of two separate film and advertising/pre-show inputs. He acknowledged marketers and creatives for having upped the content and presentation ante for HDTV. Fathom, too, stands to gain from the big-gun projectors, he anticipates. With 600-plus screens at 500 locations, NCM’s alternative-content and events division “has reached the tipping point.” This “critical mass in distribution footprint will be attracting more content” and owners of high-quality content. “The Met has put alternative content in the cinema on the map,” Hall says, crediting the Metropolitan Opera broadcasts. “Consumers are getting used to—and more and more comfortable with—seeing other things than films at the movie theatre.”

As Lionsgate Entertainment was the sole 2010 representative of the production side, vice chairman Michael Burns obviously had a few things to say about those films in theatres and elsewhere. About “the death of the DVD,” he countered that Precious had a 22% sell-through rate on day one and that they still sell an average 2,000 copies of Dirty Dancing every single day. With EPIX, the company’s premium entertainment channel with partners Viacom and MGM, reaching 20 million homes by press time, Burns feels Lionsgate now controls “our own windows.” The key to an anticipated $1.5 billion 2010 success is “not to overspend,” he advised. The 28 films released last year had an average pre-marketing cost of under $11 million.

Going forward, Lionsgate expects to develop and produce 10 to 12 movies, augmented by pick-ups and acquisitions. With $4 to $5 million more for a 3D version, Lionsgate looks at the “conversion ratio compared to 2D.” Nonetheless, Burns feels, “3D is the tail, not the dog” and “fantastic in the fight against piracy.” While in retrospect Saw VI “should have been in 3D,” he announced VII to be and to have “a great plotline to invigorate the franchise.”

Franchise or original creation, from Lionsgate or otherwise, Gabelli’s Brett Harriss thinks the picture slate looks great. Though, personally, he seems more “excited to see how the digital rollout is executed in 2010 and how 3D holds up.” To close our exclusive report, we asked him about his final analyst’s take on moviegoing. “It’s an interesting industry to be a part of right now,” Harriss assured. “It’s one of those businesses that is changing, but not in such a way that threatens the existing business model. Unlike the newspapers and Internet, where digital is upsetting the old model, digital cinema does not really threaten theatrical exhibition. It augments it.”

(**) Just as all company presentations and statements made at the conference and reflected in this article come under the usual disclaimers regarding forward-looking statements, the analysis provided by Gabelli & Company also reflects “personal views about the subject companies and their securities.”

The Gabelli Roster

Ballantyne of Omaha (AMEX: BTN): John Wilmers (President & CEO), Kevin Herrmann (CFO)
Carmike Cinemas (NASDAQ: CKEC): S. David Passman (President & CEO), Richard Hare (CFO)
Cinedigm Digital Cinema Corp. (NASDAQ: CIDM): Bud Mayo (Founder, Chairman & CEO)
Cinemark Holdings (NYSE: CNK): Robert Copple (Senior VP & CFO)
Cineplex Galaxy Income Fund (TSE: CGX.UN): Ellis Jacob (President & CEO), Gord Nelson (CFO)
IMAX Corporation (NASDAQ: IMAX): Rich Gelfond (Director & CEO)
The Marcus Corporation (NYSE: MCS): Gregory Marcus (President & CEO), Douglas Neis (Treasurer & CFO)
Lionsgate Entertainment (NYSE: LGF): Michael Burns (Vice Chairman)
National CineMedia, Inc. (NASDAQ: NCMI): Kurt Hall (Chairman, President & CEO), Gary Ferrara (Executive VP & CFO)
Regal Entertainment (NYSE: RGC): Amy Miles (CEO), David Ownby (CFO)

Cinedigm and the Digital Cinema Evolution
Cinedigm had a complex mission. Ten years ago, we set out to transform movie theatres into entertainment centers. To help replace film with a standardized digital format. To replace the physical delivery of film prints with direct deliveries via satellite. To create an integrated system to manage the multiplex from the manager’s office, turning the modern multiplex into a giant iPod, through which exhibitors could create playlists and automate operations. And to create a satellite infrastructure to allow the distribution of content to a central server, permitting the broadcast of live events like sports, music and more.

To enable this transition, Cinedigm then developed the most important component: the central library server. Our iPod. In 2004, we unveiled our Library Management Server™ and our Theatre Command Center™ software, the heart and soul of every conversion we do. In 2005, seven major studios set uniform specifications for compression, image quality, sound and security. This Digital Cinema Initiative (DCI) was critical. Also in 2005, Cinedigm teamed with three major studios—Disney, Fox and Universal—to create the framework for financing the conversion to digital cinema: the VPF Agreement.

Virtual Print Fees are now used throughout the world. Six more studios signed with us to distribute movies in digital and pay VPFs on deployed screens, which numbered just over 3,700 by the end of 2007. About 10% of North America’s screens were digital at this point and momentum was building. While enthusiasm grew, however, the capital markets stopped cold.

Interestingly, while the number of digital exhibitors held steady, Hollywood marched forward. More features were shot in or converted to 3D. Digital cinema went from a curiosity to a certainty…and digital exhibitors reaped the rewards, via higher ticket prices and packed theatres.
The credit markets unthawed in 2009. Cinedigm announced an Exhibitor-Buyer program and a $100 million commitment in financing for Phase 2, to convert up to 10,000 more screens.

Digital cinema has become synonymous with 3D, but they’re not one and the same. 3D is one chapter in a larger story, which reaches beyond the movies, into popular music, children’s programming and live national events hosted on our network throughout the country. Today’s digital exhibitors merely need to mix and match the content to fill the needs of their audience.
Ultimately, in our industry, it’s about butts in seats, and about improving the quality and range of content for fans. Digital cinema is ultimately not about technology. It’s about what you do with it!
—Bud Mayo, Founder, Chairman & Chief Executive Officer, Cinedigm Digital Cinema Corporation