Warner sends entire 2021 slate to dual release HBO Max, theaters – recovery picture for theaters unchanged

I got an earful from readers of this letter yesterday – the supposed death of movie theaters was on pretty much every major financial publication. For those catching up, Warner Media announced the following yesterday:We are announcing today that, in the United States, the entire anticipated 17-film 2021 Warner Bros. motion picture slate is going to be released throughout the coming year in theaters and on HBO Max the same day.Some of these films definitely fall in the blockbuster range and include Dune, the new Space Jam and The Matrix 4. The bears had a field day as one way to read this news is that HBO Max having these titles will lead potential theater-goers to say “I’m not buying tickets and leaving my house and maybe getting COVID, I’ll just get HBO Max for $15 a month.” The market seemed to buy into this thesis as CNK dipped 20%. Making matters worse was the less than great timing of an AMC announcement that the company needs to issue equity or look at BK.

My bull thesis on the theater industry (specifically NCMI, CNK and IMAX) is unchanged in light of yesterday’s news. Readers of this newsletter and listeners of the pod will recall that both the AMC announcement and this Warner announcement are not completely unexpected. AMC was widely expected to restructure or declare bankruptcy – its bonds have traded like BK is imminent for months. It’s the worst credit of all the theaters and the Warner news is unrelated to the company’s need to issue equity.

On Warner – this strategy is the same strategy they announced several weeks ago for WW1984 and I covered in a previous edition of Stock Talking. Notably, Warner’s CEO cites this announcement as the reason for their announcement yesterday:

As I mentioned in my post from a few weeks ago, we see an opportunity to do something firmly focused on the fans, which is to provide choice. Whether that choice is to enjoy a great new movie out at the cinema, to open up HBO Max, or to do both. For more visibility and context into our thought process, please do read the post here.

What Warner is doing amounts to a year long A/B test. They want to figure out which consumers will choose streaming and which will choose theaters. Please remember this important fact – there is currently no data on how consumers will behave given streaming and theater options on the same day. As I’m fond of telling my sports gambling friends, there’s a lot of football left to play here. The market shoots first and asks questions later – the question to be asking on this announcement is “How will the dual release strategy impact theater attendance in a variety of COVID scenarios?” If COVID is completely gone, are people going to stop going to theaters and watch HBO Max?

To the bears’ credit, a competing option hurts the competitive moat of theaters. By how much though? Recall stocks like NCMI are trading at less than 3x potential 2021+ cash flow, and that’s with haircutting it to 2019 levels. In the NCMI case, the company does $200mm of FCF in a normal year – at its current $300mm market cap, you could haircut it by 50% and the FCF yield would be 33%. NCMI gets paid on ads shown per a thousand viewers, so movie attendance is a decent way to think about the stock. Do we think HBO Max will lower theater attendance by 50% in normal times? Even this question is too generous to the bears – I’d love to buy stocks at a 20% FCF yield, so NCMI could do $60mm in FCF – a 70% decline from peak times – and the stock would still be fairly valued at today’s price. The price sets the market’s expectations, and the market has been saying movies are dead for months.

Several more key things to calm people down:

– AT&T owns HBO Max and and Time Warner. Obviously, there’s some home cooking discounts going on here. AT&T sees its subsidiaries as ways to build value for shareholders, so it’s more than willing to prioritize HBO Max subscriptions over Warner revenue if it likes HBO’s future cash flows more. There is an obvious conflict of interests here, one that other studios are not subject to. Recall also that Mulan on Disney+ was arguably a failure for Disney and that there is no evidence right now that putting movies meant for the theater on PVOD is an adequate profit replacement. Warner is one of many studios that release blockbuster films, and it remains to be seen whether other studios will do dual releases on streaming services.
– Warner’s CEO said this movie was because of the pandemic. If we take him at his word, there’s no industry shift happening here. Here is CEO Jason Kilar verbatim:

“Certainly this is pandemic-related,” Kilar said. “That’s why we’re doing it. We haven’t spent one brain cell on what the world looks like in 2022.”

For companies I own, I’m evaluating cash flows over three years at minimum, not one year. Let’s also remember there are a number of estimates out there that 50% or more of the US is vaccinated against COVID by the summer. Q3 and Q4 2021 for the movie industry is going to be interesting – I at the very least would like to see these two quarters before revising my thesis.
– CNK’s 2023 bonds are up over the last few months and currently trading at 94 – this is not a company in dire financial trouble. The debt markets – as the old saying goes, usually a step ahead of equities – is calling bullshit on the media. I bought these bonds at 85 about a month ago and sold at 89. Bonds trading at $0.94 on the dollar from my experience imply that the market sees a good probability of the company refinancing its debt. Bonds don’t trade at 94 when BK fears are on the table:

– In Q3 and Q4, the facts on the ground suggest the future for movie theaters has become significantly brighter, with the success of Croods being the most recent data point – My original post on the theater industry and follow up and podcast on NCMI with awesome guest Diligent Dollar review the massive comeback of theaters in China and Japan (where Demon Slayer set all-time box office records), loaded slates for 2021 and 2022, historical strength of box office revenues and strong liquidity of names like IMAX, CNK and NCMI (all of which can survive for a year with no revenue). Croods 2: A New Age – released on Thanksgiving – I wrote about here and shows how industry expectations are still far too low. All of these bullish signals are independent of the Warner announcement. News flow has to be viewed holistically and not in a vacuum.

To holders of NCMI (or CNK and IMAX), I recommend ignoring the financial media’s declaration that theaters are dead – let’s remember they’ve also at various points given up on Apple (can’t innovate), Facebook (will be regulated), Netflix (overvalued or competitors will destroy them), presidential candidates who won (yep, 2016 and 2020), stocks (the 1970s… the 2000s… the 2010s… March 2020), gold, bitcoin, energy, you name it. It’s popular among thought leaders and talking heads to tout PVOD over theaters in part because it sounds smart. Beware though of professorial pundits who give stock advice – here’s one that has been wrong time and time again.

Last thing – NCMI gave its investor presentation to BofA earlier this week. I recommend reading the transcript, but I’ll leave you with some quotes that stuck out to me.

I do think that the performance of Croods, the movie this weekend, was a good indication of not if this industry is going to recover, but when. And when I look at how good the performance was given that only about 45% of theaters are open, and the movie actually did even better than Tenet did when all the theaters were open, I think is some indication that consumers are going to come back. And I think that’s sort of the start of the beginning of all this…

So I don’t believe that the pandemic is going to have a significant effect on people’s behavior. And we know there’s a significant pent-up demand from all the research we’ve done with consumers. And while the various studios will be testing different windows and availability, I’m confident that consumers will come back to the theaters as soon as there’s a real release schedule and real big movies coming out, beginning with Bond in April…

So advertisers see consumers coming back. It’s really hard to quantify. And I wouldn’t want to give you a forecast just yet. But we believe the summer release schedule as it currently stands is very strong. And I think it’s likely that we’re going to see a really strong consumer presence come back this summer post the availability of vaccine and with a real release schedule that’s indicative of what has happened historically.

I’m looking to buy NCMI on any weakness from this announcement.

Happy trading,

Ben