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Equity Research L O S ANGELES | S A N FRANCISCO | NEW Y O R K | B O S T O N | C H IC A GO | MINNEAPOLIS | MILWAUKEE | SEATTLE Movies and Entertainment January 9, 2017 Michael Pachter Alicia Reese Nick McKay (213) 688-4474 (212) 938-9927 (213) 688-4343 [email protected] [email protected] [email protected] Biweekly Review -- A Look Ahead from Early January and Our Take on Current Events in Film Exhibition and Video-On-Demand • Q4 box office ended down 3.5% year-over-year to $2.81 billion, while the year ended up 2.2% to $11.4 billion – the second consecutive domestic box office record. October was down 8.1% ($657 million), with the top five films grossing over $50 million each and collectively grossing $306 million during the month. October faced a difficult comparison from The Martian and Hotel Transylvania last year, which, along with number three Goosebumps , totaled $331 million for the month. November was up 7.6% ($959 million), with Doctor Strange, Fantastic Beasts, and Trolls leading the box office and all surpassing $100 million each. December was down 8.8% ($1.2 billion), with Rogue One: A Star Wars Story generating $408 million, compared to December 2015 when The Force Awakens earned $652 million. We expect solid box office growth in 2017, but expect a challenging start to the year given difficult comps in the first quarter. • Premium ticket comparisons were difficult in Q4 and we expect difficult comparisons to a lesser extent in Q1. In Figure 2 on page 3, we compare the top ten films in each quarter to the prior year’s quarter, denoting which was or will be available in IMAX or IMAX 3D. We expect the exhibitors to report a difficult comparison in both Q4:16 and Q1:17, particularly for premium films, while we expect the exhibitors to show strong growth in premium films in both Q2:17 and Q4:17. Our model currently forecasts lower year-over-year contribution from the top 10 films in Q2:17 and Q3:17, but we anticipate solid overall growth in each quarter, with higher per film estimates as the summer approaches. We expect Q4 consensus EPS estimates for exhibitors to rise slightly as Q4 box office ended higher than expectations, likely driven by better average ticket. We think Cinemark and Regal will benefit the most given their more flexible proprietary premium large format (“PLF”) screens compared to AMC, and since AMC is comping The Force Awakens in IMAX (see Figure 3 for details on screen mix), however we think the film mix favors Cinemark over Regal given the former’s more suburban, family-friendly footprint. • IMAX faced difficult comparisons both domestically and in China in Q4, but we maintain our view that IMAX was able to achieve roughly flat global DMR revenue in 2016 driven by its expanding footprint. In Figures 4 and 5 we take a look at weekend box office results in China. It is clear that the Q4:16 box office has declined substantially over Q4:15, despite more than triple the number of films released each week compared to the prior few years. We think domestic IMAX declined in Q4:16 over the prior year given the difficult comparison from last year’s successful Star Wars release, while in China a few weekends of gains in December were not enough to offset overall declines in the quarter. Despite the expected Q4 declines, we continue to believe that IMAX achieved roughly flat global DMR revenue in 2016 driven by its expanding footprint; IMAX’s recent global box office report of $246.6 million supports this. Furthermore, we note that China PSAs have been substantially higher than the rest of IMAX’s circuit for quite some time now, and we are not particularly concerned about the reduction in PSA as it normalizes with the rest of the world. We think that IMAX’s current backlog in China is its last big push into the region, and expect the company to focus on other regions going forward. In particular, we expect IMAX to focus on its European expansion now that AMC is entering the region via its recent acquisition of Odeon & UCI. • Amazon has found several ways to compete with Netflix. In September of 2016, Amazon began offering its domestic customers a standalone video subscription (separate from Prime) on a pay-as-you-go basis for $8.99 monthly, for a total annual cost of $107.88 compared to its annual subscription cost of $99; customers are also offered Prime on a monthly basis for $10.99 ($131.88), which is a horrible deal unless the customer wishes to join for only a brief period of time. Amazon also offers Prime Video in non-Prime countries (approximately 180 of them) for $2.99 per month for six months and for $5.99 thereafter, which should cut into Netflix’s potential market share considerably over time. Amazon is now using a select offering of comedies, documentaries, children’s shows, and other content to lure non-members into in full Prime subscriptions by offering the first episode for free with advertisements. The most notable Amazon show available for free is Chappelle’s Show – The Complete Series . In our view, this addition is yet another attempt by Amazon to take on Netflix in the largely untapped SVOD market, since Netflix recently spent $60 million to gain three one-hour exclusive specials from Dave Chappelle. We estimate that Amazon spent as much as $3.5 billion on content in 2016, while Netflix spent nearly double that in 2016 as it delivered content to 200 countries compared to Amazon’s five countries for most of the year (Amazon expanded its Prime Video offering worldwide on December 14). We expect Amazon will grow its spending on video content by $500 million or more annually for the next several years overall, with most of the increase for original content. Wedbush Securities does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors Movies Movies and Entertainment should consider this report as only a single factor in making their investment decision. Please see page 20 of this report for analyst certification and important disclosure information . AMC has now completed its acquisition of Carmike, and our model reflects the integration of Carmike theaters. We expect AMC’s adjusted EBITDA to improve by nearly $150 million driven by screen growth coupled with various cost synergies. However, similar to the four quarters post its Starplex acquisition in December 2015, AMC’s growth in admissions revenue per average screen will likely underperform the industry box office. The decline in admissions revenue per average screen is driven largely by lower average ticket price throughout Starplex and Carmike circuits compared to AMC’s core circuit, as the former are located in more rural areas where ticket prices are lower. While we believe AMC is capable of driving some improvement in average ticket in its acquired circuits, we do not expect a drastic shift for its Starplex and Carmike circuits given the geographies and demographics of these domestic footprints. Having said this, we think it is important to note that even with the Starplex acquisition, AMC’s admissions revenue per average screen surpassed all of its competitors. We anticipate AMC’s Odeon acquisition to likewise lower overall average ticket in the near-term as Odeon’s circuit does not yet have premium screens equal to AMC’s domestic circuit. We estimate that AMC’s overall 2017 average ticket will go to $8.99, down from our estimated 2016 average ticket of $9.49 and average ticket of $9.61 in 2015. AMC’s metrics will appear challenged compared to the industry over the next four quarters because of this, although it is important to note that revenue and EBITDA will grow substantially. Additionally we note that despite the seemingly challenged metrics compared to its historical metrics, we expect AMC to be roughly in line with its competitors over the next year on admissions revenue per average screen (see below), and we believe that it can improve these metrics by 2018 to again rise above its competition. AMC’s Starplex acquisition included 33 theaters and 346 screens, increasing AMC’s footprint by roughly 7%. The Starplex circuit is primarily based in small-to-mid size markets, a contrast from AMC’s larger market positioning, thereby increasing AMC’s demographic diversity. We expect this to improve AMC’s ability to capture proportionally higher attendance rates for big blockbusters, however average ticket is notably lower than AMC’s average. The acquisition provides additional re-seat opportunities; 121 of the 386 screens have luxury recliners installed, and AMC stated plans to add 140 recliner screens by the end of 2016, 185 by the end of 2017, and 230 by the end of 2018. AMC’s acquisition of Odeon & UCI, the largest theater exhibitor in Europe, represents screen growth of 7,623 in eight countries, or about 42% off of AMC’s existing base. While cost synergies will likely be limited, the Odeon & UCI circuit represents a significant opportunity for upgraded theaters and concessions, and management expects to renovate approximately 500 screens with recliner seat upgrades over the next five years, including the addition of IMAX and Dolby theaters throughout the footprint to add incrementally to average ticket. After divestitures, we assume AMC will add roughly 2,738 screens from its acquisition of Carmike, resulting in $770 million in incremental total revenue, and after synergies we expect nearly $150 million in incremental 2017 adjusted EBITDA.