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The Premium VOD Battle: Exhibitors Will Win, Investment Bank Says

Bay Area firm Merriman Capital says theater chains have more leverage, and predicts they’ll actually profit in the fight over early home-release windows

Exhibitors have more leverage and will actually come out stronger in their kerfuffle with studios over premium VOD.

So says San Francisco investment bank Merriman Capital, which released a memo to investors Monday stating that "it is the exhibitors that have the most power to wield and studios are likely to bend on terms or back down completely — or risk losing their most important release window and a major revenue source."

Also read Theater Owners Ready to Retaliate Over Premium VOD

Backstory: After it was reported two weeks ago at the theater-chain trade show Cinemacon that Warner, Sony, Universal and Fox were going forward with plans to release movies eight weeks after their theatrical debut for a premium $30 viewing charge on DirecTV, exhibitors reacted with fury.

As noted in the Merriman Capital report, last week, No. 1 theater chain Regal Entertainment announced that it would cut trailers for any studio participating in the premium VOD program. No. 2 chain AMC, meanwhile, announced that it would demand lower licensing fees for any film that's shown in the premium VOD window.

Ultimately, Merriman predicts, exhibitors will be able to use those leverage points to negotiate better licensing terms. Concurrently, the firm expects, the hit from premium VOD will have a negligible effect on theater chains' bottom lines.

In short: the firm recommends to investors the three exhibitor stocks it's peddling.

"Four the top four exhibitors," the report states, film rent represents about 53-55 percent of admissions revenues. For each 1 percent improvement in film-rental costs, we estimatege this would add as much as $22 million in EBITDA for Regal, $17 million in EBITDA for Cinemark and $4 million in EBITDA for Carmike annually."

Here's the full report:

Media / Entertainment

Escalating Premium VOD Power Struggle Favors the Exhibitors


Eric  WoldGreg  Scott
Investment Conclusion

In recent weeks, the back-and-forth battle over premium VOD between the major exhibitors and studios has begun to escalate. In our opinion, it is the exhibitors that have the most power to wield and studios are likely to bend on terms or back down completely – or risk losing their most important release window and a major revenue source. We continue to recommend accumulating shares of RGC, CNK and CKEC ahead of the 2Q-4Q box office rebound and benefits to come from becoming fully digital over next 12-18 months.

Investment Summary

  • Exhibitors flexing their muscles in recent weeks.On Friday, AMC Entertainment (#2 domestic chain) stated that it would be negotiating for lower film rent costs for movies that are scheduled for premium VOD release. This stance followed statements from Regal Entertainment (#1 domestic chain) that it would both reduce the number of trailers it plays for any of the four studios involved in premium VOD – Warner Bros., 20th Century Fox, Universal and Sony – as well as refuse to play a trailer for any movie scheduled for premium VOD release (this begins on 4/15). In addition, Cinemark Holdings (#3 domestic chain) stated that it would not play any trailers or put up signage for any movie scheduled for premium VOD release.
  • Current plans are for premium VOD release after eight weeks.At this point, the current chatter out of those four studios and DirecTV is to make premium VOD movies available to consumers eight weeks after their theatrical release for a price of $30. Even though minimal box office is generated from a movie after eight weeks (we calculated an average of 97% generated in the first eight weeks), there is some concern that studios may advertise a premium VOD movie's availability prior to that, which could impact a consumer's decision to wait instead of going to the theater.
  • Exhibitors have multiple power levers to use against studios.A key thing to remember is that exhibitors have sole control over which movie trailers are shown in their theaters (they are not sold or contracted to studios). In addition, exhibitors control the signage and advertising for specific movies put up throughout their theaters. Exhibitors can also reduce the number of screens they ultimately commit to a movie or, in the extreme case, refuse to show a movie in its theaters at all. However, we believe a likely outcome is exhibitors receiving better film rent terms on movies slated for release on premium VOD.
  • Studios have the most to lose… and are likely to bend or back down.Given the significant amounts of money spent by studios to produce movies, the average box office revenues generated by them (wide release movies averaged $70M in box office during 2010 with the top 30 movies surpassing $100M) as well as the indirect influence that box office revenues have on downstream payment negotiations (premium cable and free TV), we believe studios have the most to lose from either reduced movie awareness (trailers, posters, etc.) or absolute boycotts of individual films. For this reason, we believe that studios – if they truly want to stand firm on their plans for premium VOD – will end up bending on terms with the exhibitor. However, we would not be surprised if premium VOD plans are curtailed (e.g., limited to non-blockbuster or independent films) or abandoned completely after all is said and done.
  • Better film rent terms could meaningfully boost profits.Should studios agree to give exhibitors better film rent terms (the companies' largest single expense line), we could see a meaningful boost to profitability levels for a threat that we do not believe will end up being much of one. For the top four exhibitors, film rent represents about 53-55% of admissions revenues. For each 1% improvement in film rental costs, we estimate this would add as much as $22M in EBITDA for Regal, $17M in EBITDA for Cinemark and $4M in EBITDA for Carmike annually.
  • Reiterate Buy ratings on RGC, CNK and CKEC.We believe the shares of exhibitors are poised to move higher in the coming months as box office trends improve (starting with 2Q where we estimate 44% of this year's blockbuster sequel box office will be generated alone), the benefit from 3D ticket premiums increases from current levels and they approach being 100% digital (which will drive operating improvements and ability to show more alternative content). We see upside for RGC to $16.00-18.00 using 7.0-7.5x our FY12 EBITDA estimate, upside for CNK to $23.50-26.00 using 6.5-7.0x our FY12 EBITDA estimate and upside for CKEC to $8.50-11.50 using 5.5-6.0x our FY12 EBITDA estimate.

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