Summer Movie Flops Still Present Reel Opportunities

We’re still days away from August, but this summer is already being labeled the “Summer of the Mega-Flop.” Hollywood’s big-budget releases are as full of action sequences and special effects – but not the box office results, it seems.

“R.I.P.D.” – with a $130 million budget and a seventh-place, $12.8 million opening – is just the latest in a string of costly productions that have disappointed both audiences and studios. Animated comedy “Turbo” failed to get families racing to theaters. “Pacific Rim” – giant robots fighting interdimensional dinosaurs! – managed to top the international box office last weekend, but packed much less punch in the U.S. “The Lone Ranger,” “White House Down,” and “After Earth” have also failed to connect with audiences despite huge marketing efforts.

Despite all those high-profile blockbuster busts, movie theater stocks are still faring quite nicely, thank you very much. So don’t count on taking advantage of the studios’ dearth of megahits to pick up a bargain among these theater chains. While the S&P 500 is ahead 18.5 percent for the year, Regal Entertainment (NYSE: RGC), the industry’s single biggest publicly traded player, has soared 37.6 percent. Carmike Cinemas (NASDAQ: CKEC) has rallied 24.6 percent. Only Cinemark Holdings (NYSE:CNK) is lagging the broader market, but its year-to-date gain is still a respectable 13.2 percent.

Given the dearth of blockbusters, the proliferation of alternatives to theaters like Netflix (NASDAQ: NFLX) and Hulu (to name only two) and plenty of other entertainment options, this rally seems a little illogical, especially in light of the news that Walt Disney (NYSE: DIS) and Sony Entertainment (NYSE: SNE) are trying out (in South Korea) a plan to offer newly released movies via video-on-demand only weeks after they have opened in theaters.

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It’s early days, but if the experiment works, look for movie theaters to come under pressure from studios to waive their insistence on having at least a 90-day window to maximize ticket sales before the distributors and studios begin cannibalizing those revenues by making the movie available in some other way. 

One reason that Regal and some of its rivals are doing better than you might expect boils down to basics: They are delivering on the earnings front. Regal announced Thursday that its second-quarter earnings totaled 36 cents a share, better than the range of 31 to 33 cents a share that analysts had predicted and significantly better than the year-earlier level of 25 cents a share.

While Carmike fell short of analysts’ forecasts that it would earn 41 cents a share, it wasn’t by much: Earnings came in at 38 cents a share, up from 7 cents in the prior year. And in contrast to the overall trend, Carmike’s revenues were higher than expected. Regal boasts a dividend yield of 4.37 percent that looks attractive even after the jump in interest rates that we have witnessed over the last two months; that of rival Cinemark isn’t all that far off at 2.86 percent. (Cinemark’s earnings are due out next week.)

While box office results dictate the fate of these companies in the near term and the longer run, in the medium term what investors are eyeing is the potential for consolidation within the industry. So what if box office revenue this year doesn’t match the record $10.8 billion registered in 2012? More efficiently run theaters (more screens, fewer seats per screen, higher ticket prices, lower costs and more flexible scheduling) means that even without a long list of Big Summer Movies, it’s still possible for these chains to turn in respectable earnings.

One of the most active in pursuing efficiency is Carmike, the smallest of these three and the biggest player in the country’s smaller markets, where there is less competition (if you want to see a movie in Chattanooga, you’ll be contributing to Carmike’s revenues and profitability). CEO David Passman noted that the company’s second-quarter ticket sales jumped nearly 25 percent over year-ago levels, or 14 percent on a per screen basis – almost double the industry average.

The others? Well, Regal is clearly one of the two dominant industry players (alongside non-public AMC), while Cinemark has been relying on its robust Latin American assets to generate growth.

Then there is the M&A story. While none of these three players is likely to end up as a consolidation target, all will be prowling the landscape looking for small acquisitions they can tuck under their wings. Just take a look at the fate of the theaters once owned by Rave Cinemas, a Dallas-based chain launched in 1999. In a series of deals last fall and winter, Rave agreed to sell 16 theaters (and their 251 screens) to Carmike; 32 locations to Cinemark, 10 to AMC and a single theater to another small player, Starplex. The Cinemark transaction was completed in May after receiving antitrust approvals; the closing was conditional on the sale of some Cinemark/Rave screens, most of which were snapped up by Carmike in a deal announced earlier this month.

Is your head reeling yet? The bottom line is that analysts expect all three major players to be aggressive rivals in the pursuit of just this kind of bolt-on acquisition. The winners will be those that can pick the right assets, negotiate the right price and then operate the new theaters the most efficiently.

Don’t misunderstand: Some summer blockbusters between now and Labor Day would certainly be very welcome to the theater operators. But if they had to rely on Hollywood’s ability to generate a constant string of irresistible films, why invest in them at all? It would make more sense to stick to investing in the studios themselves, like Lions Gate Entertainment (NYSE: LGF).

So instead of being distracted by the question of whether the success of “Iron Man 3” is going to offset the underwhelming “White House Down” in terms of box office revenues, you’d be better off paying attention to the ability of the chains to contain costs and expand strategically – and even to the increased bargaining power that they may have when it comes to how revenue is split between them and the studios in the wake of the recent failures. Hollywood may be sexy (at least from the outside), but when it comes to the business of going to the movies, it’s as pedestrian as figuring out how good a given chain is at persuading moviegoers to supersize their popcorn and drinks.