IMAX and the future of 3D movies – James Cameron’s Reflexive Point of View

Fascinating Forbes article here about perception and reality in relation to 3-D movies:

http://www.forbes.com/sites/dorothypomerantz/2011/09/21/how-james-cameron-hopes-to-defeat-the-3-d-hype-cycle/?partner=yahootix

James Cameron’s Reflexive View

Reflexivity is based on the theory that perceptions influence reality, and reality influences perceptions. A misperception could influence reality just as much as an accurate perception.

Here is Gartner’s prediction of the public perception of a hyped trend:

Hype over time. (c) Gartner.

As James Cameron points out, the chart represents perception, not what is certain to be reality. But, he also points out the possible risk in this scenario.

If the “Trough of Disillusionment” grows too great, that is, if the studio’s misperception about the state of 3-D persists, and the public’s willingness to spend on 3-D remains at low levels, studios may act on that misperception, and actually change the reality of 3-D movies – they will stop rolling out 3-D features.

James Cameron’s approach is to alter the studio’s perception by re-releasing a blockbuster, Titanic, in 3-D, at great expense of time and money, so that studios will follow suit. Perhaps it is working; Star Wars, Episode I: the Phantom Menace, is scheduled to be re-released in 3D next year.

I am not as optimistic as Cameron on the future for 3-D as an omnipresent technology. I believe that the roll-out of cable television in 3-D will not be widely accepted until 3-D technology no longer requires glasses to view. Since Cameron mentions that television is instrumental to 3-D technology becoming ubiquitous, and since the state of 3-D television and 3-D movies influence each other, I believe we are far from that time currently.

I think that the real reason behind this trough of disillusionment is that the studios have simply not rolled out movies that were visually stunning enough. No movie has come close to what Avatar did in terms of visual effects.

For a movie to be truly worth the extra cost of 3-D, they have to play with depth perception. Vast shots, landscapes, and explosions all hold promise. But perhaps most promising is outer space.

No Science Fiction movies with wide mainstream appeal have hit theaters this summer. I feel that the kind of fandom that Science Fiction engenders is unrivaled across the genres. Sci-Fi fans are probably more willing to spend extra to improve their experience.

This is why I think that a Star Wars 3-D reboot is a great idea. The fact that the Phantom Menace is coming out next year only reinforces my idea that the 2012 upside for IMAX is enormous.

Conclusion

If the theaters continue to avoid the kinds of movies that 3-D truly benefits from, this could translate into increased disillusionment, and decreased spending by studios on 3-D conversions. This constitutes a MAJOR RISK to IMAX. In fact, this misperception may have already started a reflexive process to the downside of 3-D movies, that may be unavoidable, even with the 2012 movie slate.

If studios decide to continue 3-D re-releases of an old franchises, and the likely blockbusters of 2012 (Avengers, Hobbit, Amazing Spider Man, Dark Knight Rises, Men In Black III) are successful in 3-D as well as 2-D, then perhaps this reflexive process can be undermined.

Time will tell on this one. I am considering purchasing more shares of IMAX, believing we are only in a “testing” period of the public’s fascination for 3-D movies that will end when more appropriate 3-D movies come out.

Disclosure: I own shares of IMAX.

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Greece and Europe

Greece. Wow. What a bad situation. Is there a reflexive process occurring here? The government’s implementation of austerity measures might be further fuelling Greece’s inability to collect revenue. I am reminded of the Laffer Curve – maybe Greece is edging further into the right-hand portion.

Maybe its economy will never recover.
But what will happen? Surely the other European countries will not let Greece default. The fear of the consequences to THEIR economies is too great.
There is only one recourse for the Eurozone. Let the printing presses fly.
Perhaps by printing huge amounts of money, and loaning at low interest rates, contagion spreading from Greece can be avoided. But the situation for Greece itself will be awful for years to come.

If the rating agencies devalue Italy’s debt, or Italy’s creditors themselves get scared and jack up interest rates, Italy could be in danger of a default as well, and also require a bailout. If this occurs, the ripple effects would be enormous. Likely Portugal, and perhaps Ireland, would be next on the list.
No matter what happens, the Euro is going to MASSIVELY devalue over the next several years. The dollar is a possible benefactor, but the obvious benefactors are the currencies of Asia. I am particularly interested in Southeastern Asian countries. Those south of China, with more free currency policies.

I wonder what the impact of the massive influx of Euros will be on the energy industry.
Norway is a strong benefactor here, and perhaps Europe’s most important source of oil (1). I was so impressed by the description of integration of 4D technology in offshore Norway – this technology will become a staple of the industry in the future (2).
While (1) points out that Norway oil exports have hit a peak already, I would argue that the integration of new technologies such as 4D seismic will allow for greater recoveries than had ever been imagined in the past, and that Norway’s fields still have many good producing years ahead.
I did not realize that Denmark was also a significant producer.
I do not imagine demand will be very high in Europe over the next few decades. It will probably remain at current levels – the only impetus for price increase here is the constriction of supply. Further, increasing demand in other parts of the world also constricts supply.

(1) http://www.spe.org/ejournals/jsp/journalapp.jsp?pageType=Preview&jid=EREE&mid=SPE-96400-PA
(2)http://www.theoildrum.com/story/2006/9/22/95855/4850

ICE – Intercontinental Exchange

I took a nibble on ICE. Okay, I took more than a nibble.

I started out with about a third of the position size I wanted ideally, given the right prices. However, I don’t think prices are as good as they can get on ICE right now. However, I am reminded of the old Buffett saying: “A good company at a moderate price is better than a moderate company at a good price.” I am also reminded of Peter Lynch’s advice in One Up on Wall street: If a stock you like is too expensive, buy a small position so you can track it, and add to it later if it gets cheap.
So I took a small nibble at first. But I couldn’t help myself. I wanted to put more in – my gut was telling me to. So I doubled my initial position.
I just hope that an international disaster in credit default swaps doesn’t take out ICE’s guaranty fund. That is the risk here. But this source of risk is actually one of tremendous upside as well. Banks hedging risk and speculators are bound to be gobbling up credit-default-swaps on the European debt right now, and as long as massive defaults do not occur, the tremendous volume could be very profitable for ICE.

I own shares of ICE.

ICE – Intercontinental Exchange

I am suffering from an abundance of stock ideas.
The recent market downturn has created so many opportunities, I am reluctant to choose.
But, as always, capital is limited, So let’s start at the top of considerations.

ICE – this has been on the list for some time. The rich cash generation and durable competitive advantage – in the form of regulatory licensing – make this a strong company with a wide moat around its business. ICE has been eating into the business of it’s main competitor, CME, for years. Keep in mind, I am bullish on CME as well, together these companies have a duopoly of energy and soft commodity trading in the US and most of Europe.
But ICE is the fast growing new kid on the block.
I am currently more bullish on Brent crude volumes, which are primarily traded on ICE’s systems, than WTI crude volumes, which are primarily traded on CME’s system. The WTI is currently a “land-locked” crude – and prices are being discounted because the oil stored at Cushing, Oklahoma is not available for easy transport to refineries at the Gulf. All pipelines from the Gulf are pumping oil from the Gulf to the inland, and there are currently none the other way. So, WTI has been dealing with a price depression because of the glut of oil accumulated at Cushing with nowhere to go.
What does this mean for ICE? Brent crude (ICE’s benchmark oil product) is carrying a price premium right now because of its sea-borne nature – it is based on North Sea oil – and easy transportability. Further, speculators are pushing up Brent prices because of unrest in the Middle East – a bet that Europe may have to depend less on Middle Eastern oil in the future, increasing demand for Brent crude.
The fact that Exxon and BP have both been eyeing the Arctic circle for new exploration activity also bodes well for Brent Crude volumes. Any new exploration in the Arctic circle is sure to have crude that is priced relative to the Brent benchmark, and should increase volumes for that product as the producers seek to hedge their prices.
I will confess, I am a little uneasy about ICE’s CEO, Jeffrey Sprecher. Sprecher is a seemingly incourigible optimist, but the attitude has served him very well in his time at ICE. However, I was rattled by ICE CEO Jeffrey Sprecher’s decision to join with Robert Greifield of NASDAQ in making a rival bid for the NYSE Euronext exchange. While the Liffe business (the part of NYSE for which ICE was bidding) has a durable competitive advantage – the LIBOR product traded on the Liffe platform is widely tracked across the banking industry – I felt that the offer was high relative to the value of the business. I also was slightly worried that ICE’s balance sheet might tip too debt-heavy, though, as Sprecher was eager to point out, ICE’s rich cash flow can handle a substantially larger debt load than it currently does. I was glad this deal did not go through, and that instead, ICE will be looking to invest elsewhere.
Another reason this rattled me so much is that it happened so quickly I wondered whether ICE management was accurately weighing the risks of the transaction.
However, I do respect Sprecher’s willingness to continue to invest in acquisitions to grow ICE, and his forward-looking vision that allows ICE to take risks to enter profitable markets well ahead of competitors, as long as ICE is not taking on serious amounts of leverage to do so.
I believe, in addition to its energy Futures, over-the-counter (OTC) energy, soft commodities, metals, and forex markets, ICE is primed for massive growth in a couple of new markets. ICE owns the largest carbon credit exchange in the world by volume (1). California has recently pushed through cap and trade legislation, and the European Union Emission Trading Scheme has been in effect since 2005. Though this market currently contributes only a small amount of revenue, in future years it holds the potential for growth.
ICE is still the ONLY service cleared by regulators for Credit Default Swap trading. Now, the rules are still being sorted through with regulators as to how this market will be governed, but one thing is for sure: CDS trades will be transferred onto a transparent exchange and clearing service, and, as a first-mover into this industry, ICE has set itself up to have the advantage over rivals like CME and whoever else chooses to enter the market. However, there are still risks I am worrying about related to this business. For example, ICE has a Guaranty Fund to cover the default of up to 2 of the largest Clearing Participants. However, if a major credit default event occurred, would ICE be liable for defaults over and beyond the 2 largest? Granted, this could only happen in a second “financial armaggedon” type scenario, but it is something good to know. I will have to comb over some conference calls to see if this has been covered. For more information on ICE’s CDS clearing business, see (2).
Another exchange battle with CME is occurring in Brazil. CME has traded stock with BMF Bovespa, the leading Brazilian exchange, in a 5%/5% swap. This has primed CME for the explosive growth that Brazil is experiencing. However, ICE has bought into Cetip, a second Brazilian clearing firm, and plans to create competition to BMF Bovespa in electricity trading. this could be a potential source of growth, but, of course, is nothing to count on.
ICE management recently acknowledged that they may begin a more rigorous share buyback program, as the market has not yielded any more prime deals.
But, as rumor would have it, the London Metals Exchange is being courted by a possible suitor. It is not wise to believe every rumor that you hear, but if this is true, I think this would be a great complement to ICE. LME still conducts much ots trading by the open-outcry system, complete with a trading pit and floor traders. Such a system is unnecessarily costly to operate. As ICE demonstrated with its 2001 takeover of the International Petroleum Exchange, conversion from the open-outcry system to an all electronic system can save money and widen margins for the exchange while lowering spreads and reducing transaction costs for market participants. If the rumors are true, and if ICE can get its hands on LME, it could hold a great potential upside.

As far as exchanges go, my favorites are still the two competitors*, CME and ICE. Recent declines in CME have offered tremendous value in that stock as well. But ICE remains the stock with the largest potential upside, and management that is focused on continual growth.

I currently own shares of CME, but would like to purchase shares of ICE soon, definitely before ICE reports on November 2.

(1)http://www.bloomberg.com/news/2011-02-24/ice-to-publish-serial-numbers-for-unusable-emission-credits-1-.html

(2)https://www.theice.com/publicdocs/ice_trust/ICE_CDS_Buyside_Clearing_Overview.pdf

(3) ICE’s latest 10-Q http://www.sec.gov/Archives/edgar/data/1174746/000119312511207376/d10q.htm

* I am currently investigating the Singapore Exchange (SGX). The net profit margins for this exchange are VERY wide, and the exchange looks attractive, as Singapore is rapidly becoming a trading hub. As it is a foreign stock, I would have to purchase over the counter, which makes me a little more cautious.

IMAX – the Upside

IMAX is a great stock waiting for its day… Or, rather, its year. The success of IMAX depends largely on the success of blockbuster movies – the kinds of movies with enough spectacle to entice people to pay extra for IMAX’s huge curving screens.
Avatar was the perfect example of such a film, and, accordingly, 2010 was a record year for IMAX.
Unfortunately, the first half of this year was lacking in huge blockbusters.
Transformers was the only real blockbuster in the last quarter, and most of these profits are booked in the quarter ending October 1 (Q3).  Harry Potter is the movie that promises to bring the greatest ticket sales, and ALL of these profits are booked in Q3. Thus, when IMAX reports Q3 profits, the market will likely be in for a surprise. I am expecting IMAX to report earnings this quarter that equal or exceed the earnings for the entire first half.
But the really exciting upside for IMAX is 2012. We keep seeing signs of an incredible movie slate next year: The Avengers, The Dark Knight Rises, The Hobbit, The Amazing Spider-Man – these are all sure to be huge blockbusters.
While we cannot expect Avatar-like success from any one of the 2012 films, the fact that there are at least four potential blockbusters (plus Man of Steel in January 2013) points to a year with similar potential.
To get a sense of the magnitude of this potential, lets consider the income earned in 2010. IMAX was able to pull in $100mm, with a pre-tax profit margin of 20%. This was largely due to the success of Avatar during the first quarter – evidenced by the fact that they earned the majority of 2010’s income in the first four months of 2010. If IMAX could earn the same amount of income in 2012, it would stand at a P/E of 10, given the market’s current valuation at $1B.
This is entirely too low for a growth-y name like this. IMAX built 88 new theaters in 2010, and has built 42 more so far in 2011, mostly in the United States, Europe, and China. IMAX makes a higher profit margin on its international theaters than US or Canadian theaters, so it has been pursuing these opportunities more aggressively in recent years.
China seems to be a market with an exploding movie theater industry, and IMAX has been positioning itself for the past couple of years to take advantage.  As of June 30, 2011, IMAX had 46 theaters in China, but these only bring in about 8.5% of the revenue. IMAX CEO Richard Gelfond has said he thinks IMAX can have 80 theaters in China by the end of 2011 – I think he is too optimistic. Current plans include 300 new theaters by 2016, which would represent a 53% increase over today’s 560 theaters world-wide. (1)
Future plans aside, let’s focus on the theaters IMAX currently has open.
71% of IMAX’s 560 theaters are in the United States (57%), Canada (5%), and Western Europe (9.5%), which we can rely on to have fairly similar tastes. These theaters currently bring in ~83% of the revenue.


We know that the franchises of the Dark Knight, The Lord of the Rings, Iron-Man, and Spider Man have been huge hits. In general, sequels, especially in these franchises, tend to perform on-par with or better than the originals. I believe that it is currently time to take advantage of the low pricing on IMAX stock to prepare for a major cyclical upswing when the 2012 movie slate hits.

References:

(1) Pierson. China is on a cinema-building binge. L A Times. http://articles.latimes.com/2011/mar/06/business/la-fi-china-cinema-20110306

(2)IMAX SEC filings. Mostly 2010 10-k. Some previous 10-k’s and 10-q’s. http://www.sec.gov/Archives/edgar/data/921582/000095012311017825/o67926e10vk.htm

Disclosure: the author currently owns shares of IMAX.