Pay Attention To The Box Office
There are a few things I like more than watching a good movie. You sit in a dark room. Munch on popcorn and cover your teeth in candy. Wash everything down with a cold pop and immerse yourself in a couple hour event that transports you to the universe of someone’s imagination. Horror movies and thrillers are my favorite. I have been waiting patiently for October to roll by so I can re-watch David Lynch’s Mulholland Drive in the comfort of my home.
Given my fascination with the big screen, I was naturally drawn to the business model of the cinema. As an operator of a movie theater you control a large piece of real estate and rent out seats in a big room for patrons. You split the revenues almost 50/50 with the producer of the film and upsell your customers on overpriced popcorn, candy and pop. Costs include labor, electricity, property taxes, cost of acquiring food, etc. Margins are strong when theaters are filled and your customers leave the theater in amazement at the work a producer creates.
The business model of a movie theater is quite simple when you think about it and generates strong free cash flow. There is little in working capital and if you can keep your theaters filled you can cover all overhead expenses to generate a reasonable rate of return for your investors. For years, the movie theater industry was one of the best kept secrets on Wall Street.
Then the brutal year of 2020 happened and all movie theaters were forced to shut down. No one ever predicted their once cash flowing movie theaters would ever shut down for a long period of time. And when the pandemic subsided and the government allowed you to go back to the theater, movie studios were not releasing any new content so you had no content to show. Theaters were written off as a dead asset. Streaming appeared to have won. Discount rates on public theater companies skyrocketed as investors required a nosebleed rate of return to invest in a dead asset.
I made a lot of money on theater stocks at the 2020 lows when everyone thought the space was dead in the water. When assets get priced under their real estate replacement value its time to take a hard look and focus on the next three years, not the next three months. Eventually, the box office started to bounce back and combined with government support programs, all public theater companies made it out alive.
Theater stocks ran up too high and I sold my holdings. Fast forward to 2021 and the box office improved, but was still down 61% from 2019 levels. Theater stocks sold off as investor anticipated a permanent impairment for the industry. This is when I got interested again.
The great thing about the movie theater industry is that you get a daily gauge on the health of the domestic box office. Thanks to Box Office Mojo, we can see how many movie theater tickets were sold on a daily basis.
The box office has slowly started to roar back in 2022 and July is set up to be the best month in years. With six days left in the month, July is likely to surpass $1 billion in box office revenue, which we haven’t seen since December of 2019. As a reference, in July of 2019, the domestic box office was $1.2 billion. In June of 2019, the domestic box office was $991 million. We are close to getting back to 2019 revenues and public movie theater stocks have not flinched.
I’ve been accumulating one small movie theater company and have been thinking about buying another one. I’m not touching AMC as their market cap is $8 billion with the domestic box office selling $10-12 billion in annual revenue per year. AMC definitely doesn’t control 80% of the box office and they have another $10 billion in debt that they will never be able to service.
Instead I am buying small movie theater companies that own and control real estate assets and have clean balance sheets that will allow them to survive any prolonged downturn. I think the owned real estate assets for both companies eclipse the current enterprise value and the return of the box office provides upside torque over the next few quarters when analysts, asleep at the wheel, realize we are back to 2019 box office levels. I love finding companies with limited downside, protected by real estate, and near-term upside from an improvement in earnings.
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