Description

This is a timely idea. 

On 12 July 2023, IMAX Corporation launched a HK$10.0/share bid for its Chinese subsidiary IMAX China. That bid failed due to widespread opposition from the minority investors in IMAX China. Under Hong Kong Stock Exchange rules, over 70% of the disinterested parties have to approve a bid and no more than 10% reject it. In this case, 18% rejected the offer, causing it to fail. 

Parent IMAX Corporation responded influencing IMAX China to cut its dividend, causing some minority investors to sell their shares and for many others to become disillusioned. Since the failure of the bid, IMAX China's stock price has been range-bound at around HK$7-9/share. 

In any case, I believe that IMAX Corporation is about to launch a new bid for IMAX China after it's allowed to do so from 10 October 2024 onwards. 

I believe that IMAX Corporation is about to launch a new bid for its Greater China subsidiary IMAX China  after 10 October 2024. It's no secret that CEO Richard Gelfond wants to privatize the business, especially at the current valuation, which practically everyone seems to agree undervalues the business. 

So why do I think that a new bid is coming? 

• In its 1Q2024 earnings call, IMAX Corporation CEO Richard Gelfond said they would like to take IMAX China private. But that it ultimately depends on the company's financial performance, whether they can line up funding and whether minorities will accept any offer. In Gelfond's own words: "it would be nice if we could do it". 
• On 17 May 2024, IMAX China eliminated the positions of Chief Financial Officer and Chief Operating Officer after Ms Jianing Chen tendered her resignation. The fact IMAX China did not replace her seems to suggest that her job will be taken over by somebody, presumably within IMAX Corporation's finance department. The lines between the two businesses are getting blurry. 
• A recent job posting for a finance director at IMAX Corporation’s offices in Ontario, Canada is looking for a person to "standardize and harmonize accounting controls and processes” at IMAX China. This language is new and seems to suggest that IMAX Corporation wants to fully integrate its subsidiary. 
• IMAX China currently trades at a valuation of 5.0x EBITDA vs IMAX Corporation's own 9.4x EBITDA. Richard Gelfond comes from a private equity background and understands how to create value for shareholders.  
• A takeover would reduce the costs of having two separate listings, with savings estimated at around US$2 million per year. 
• IMAX China has tax credits of $5.2 million that can be carried forward and reduce future income taxes for IMAX Corporation post-takeover. 
• An acquisition would also make it easier to introduce new products in China. Gelfond has previously said that because of Hong Kong Stock Exchange rules, it's "cumbersome" and "bureaucratic" to launch new products into that market. 

If a new offer materializes, it will most likely be done at well above HK$10.0/share, perhaps closer to HK$12 (~8x EBITDA). The shareholder register hasn't turned over materially and is unlikely to accept another HK$10 offer. So at the current share price of HK$8.5/share, I think there's still asymmetry in the range of potential of outcomes. 

During the 2Q2024 earnings call, IMAX Corporation's CFO said that "[their] incentives of taking [IMAX China] private have decreased" following organizational changes and tax efficiency gains. But I'm pretty certain that Richard Gelfond wants the transaction to go through. The only question is - at what price. 

Is it a decent business? 

I think so. The IMAX brand name is incredibly strong in China - in fact, even stronger than it is in the United States or elsewhere. IMAX China has an exclusive license to sell IMAX equipment within the Greater China region. They either sell equipment straight to cinemas and get paid in a lump sum, or through revenue sharing agreements with theatres. IMAX China also makes money from the conversion of movies into IMAX format, with parent IMAX Corporation serving as a supplier. Roughly 70% of IMAX China's revenues are recurring though dependent on the Chinese box office. 

IMAX is worth the ticket price for epic movies like Dune & Dune 2. The IMAX equipment offers better viewing experience thanks to larger screens, steep seating arrangement, taller aspect ratios, better resolution and better sound. While there are alternatives to IMAX, many movies are now recorded with IMAX cameras, and many more movies are converted to the IMAX format. It would difficult for an upstart to compete when studios are already committed to converting their movies to IMAX. Even Dolby has found it difficult to challenge IMAX on its home turf. I think the brand name and entrenchment in the industry are the primary explanations for IMAX China's superior 40% margin. 

There's still some untapped growth. IMAX China has around 800 screens in China, giving them a 1% market share. Ticket prices are far higher than for normal cinemas, giving them an overall market share of 4%. IMAX China's market share dropped a bit during the pandemic due to a lack of Hollywood blockbusters, but that market share has already come back levels higher than in 2019. IMAX thinks that they could add another 427 screens in China, suggesting a 50% higher screen count than today. Though most of the growth will come from a higher screen count, as prices are already high. 

A key worry in the past has been IMAX China's reliance on the popularity of Hollywood movies within Mainland China. But the Chinese movie industry has made strides in recent years. In 2019, Chinese movies represented only 31% of IMAX's box office revenues. Last year, that number increased to 62%. The number of local language titles available in IMAX Cinemas will be higher this year than in 2023. And the number of local language films in 2023 was twice as high as in 2019. The Chinese movie industry is committed to IMAX. 

The 2025 Hollywood movie slate looks fantastic. The industry suffered throughout the COVID-19 pandemic. And 2024 has been tough due to the lasting impact of the Hollywood writer's strike. But from the second half of 2024, the number of new Hollywood movie releases is accelerating. Exhibitors are predicting that 2025 will be the best year since the 2020 pandemic. In Richard Gelfond's own words: "With the slate strengthening in the second half of 2024 and an extremely promising outlook in 2025 and 2026, we expect sales activity and installations to accelerate". 

Earnings are difficult to forecast given that the cinema industry hasn't fully recovered from the COVID-19 pandemic. But assuming a 94% recovery by 2025 in nominal terms and an operating margin of 43%, you get to a P/E ratio of 9.1x and an EV/EBIT of 5.8x. I'd be happy to own the stock into 2025 regardless of whether a new bid is coming or not. Two insiders in IMAX China bought shares right after earnings were released in August, suggesting optimism for the future. 

The main risks are related party transactions, or IMAX Corporation screwing over IMAX China minorities somehow. But after the failed acquisition, IMAX Corporation hasn't played around with transfer pricing, and IMAX China remains incredibly profitable. So I think it's too simplistic to say that IMAX China is run in the interests of its controlling shareholder. The only thing I can fault them for is cutting the dividend in 2023, when IMAX China's balance sheet clearly supports a generous dividend policy.  

A full introduction to IMAX China can be found here. 

Catalyst

Privatization offer post-10 October 2024

Better 2025 Hollywood movie slate