Make no mistake, I love watching films in the mega-format provided by Imax Corp (NASDAQ:IMAX). IMAX has always made a tremendous product, and created movie experiences that are worth the extra expense. However, IMAX stock itself has been driven by a weird sort of cult optimism that is not reflected in its financials or its business model.
The IMAX stock business model has, for the most part, centered around installations and upgrades. A much-and-still-hyped avenue for revenue was a joint revenue sharing agreement IMAX had with studios for certain films show in IMAX theaters. Yet these arrangements never really materialized into the kind of boffo numbers that bulls hoped for.
IMAX has done just fine over the years, but has never been a growth company. Yet IMAX stock has been priced as if it were some mega-growth company – selling for over 100x earnings for quite some time.
So, as it is, IMAX stock valuation has always teetered on the precipice. Now, thanks to the ever-opaque way that business operates in China, IMAX stock has been hit due to a major change in IMAX’s fastest-growing market.
China Giant Screen (CGS) is a subsidiary of state-owned China Film Co., which is responsible for importing and distributing U.S. films. CGS has been providing large-scale screens, 288 thus far, in China. IMAX has 430. However, CGS just announced some very big and disconcerting news for IMAX stock:
“We have a government mandate to become the largest premium, large-format brand in China’s film market and we are confident of achieving that target in 2019. Our top priority is expansion, not profitability.”
A government mandate? Expansion, not profitability? In other words, the Chinese government is going to take on all the costs to expand the heck out of CGS product. That’s because CGS is owned by a state-owned firm. And like any government-subsidized venture, profits don’t matter whereas they do with IMAX.
Worse, China is a huge part of IMAX now. From the IMAX 10-K:
Greater China continues to be the Company’s second-largest and fastest-growing market, measured by revenues. In recent years, the Company’s Greater China operations have accounted for an increasingly significant portion of its overall revenues, with approximately 31% of overall revenues generated from the Company’s China operations in 2016.
As of Dec. 31, 2016, the Company had 424 theaters operating in Greater China and an additional 334 theaters in backlog that are scheduled to be installed in Greater China by 2022. The Company’s backlog in Greater China represents 67.1% of the Company’s current backlog. The Company continues to invest in joint revenue sharing arrangements with select partners to ensure ongoing revenue in this key market.
IMAX is also under the control of the state as far as what films are and are not permitted to be viewed in China. The country already has a vibrant production industry, and Chinese filmgoers are more likely to enjoy Chinese films than American films, just as anyone is any culture will always prefer to see their own faces on the screen.
That means CGS can also corner the market on blockbuster Chinese films.
To me, this seems like a clear assault on IMAX’s China business, which means more holes in the IMAX business model.
I would sell IMAX.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
