Get Ready for a Breakthrough in This Industry

If you’re tired of paying $10 for a movie, it may be time to do something about it.

My motto: If you can’t beat ’em, invest in ’em.

Though some say no one goes to the movies any more, the theater business is making plenty of money. The U.S. domestic box office has held steady during the downturn and Nielsen data shows revenue is up +4.6%. The numbers aren’t an aberration: Box-office revenue has grown about +5% annually during the past 15 years.

The rationale is simple: A night at the movies is still cheaper than a sporting event, theme park or a weekend getaway. The numbers show that moviegoers are willing to shell out for a movie ticket, popcorn and a little escapism during the recession.

This is encouraging news on its own, but there are better things in store for the movie business besides a resilient consumer base: A breath-taking technological development. If all goes according to plan, this catalyst will be a game-changer for the theater business.

The catalyst is 3-D movie technology. It has the ability to juice per-screen revenue by +250% to +300%. In their limited run so far, 3-D movies have been a hit, grossing more than $1.2 billion at the box office.

3-D Movie Title Total Box Office Release Date
Up $292,810,074 05/29/09
Monsters Vs. Aliens $198,351,526 03/27/09
Ice Age: Dawn of the Dinosaurs $196,112,522 07/01/09
G-Force $118,302,194 07/24/09
Cloudy With a Chance of Meatballs $108,201,645 09/18/09
Coraline $75,286,229 02/06/09
The Final Destination $66,083,246 08/28/09
My Bloody Valentine $51,545,952 01/16/09
Toy Story / Toy Story 2 $28,554,678 10/02/09
Jonas Brothers: The 3D Concert Experience $19,162,740 02/27/09

Theaters must make a significant up-front investment to enable them to show 3-D movies. They must buy digital projectors, special screens and more bells and whistles that can add up to $100,000 a screen. The industry was caught off-guard during the credit crunch and was unable to secure financing to upgrade enough screens to support a release entirely in 3-D.

#-ad_banner-#When audiences are willing to pay $15 for a 3-D movie instead of the $7-$9 for a typical feature, a theater that can’t show 3-D films is losing potential revenue. The United States has fewer than 3,000 3-D screens, and theaters often have to bump a 3-D picture off the screen when a new 3-D movie is released.

Thanks to a loosening credit market, that’s changing. Theaters are on track to install another 5,000 3-D capable screens by 2010.

Not only does 3-D technology interest theater owners, it also has broad appeal to movie studios. They hope 3-D movies will bolster returns and fend off competition from other media like cable television, Blu-Ray movies and on-demand programming.

Disney’s (NYSE: DIS) Pixar studios, along with DreamWorks Animation (Nasdaq: DWA), have committed to releasing all of their films in 3-D, but the big test for the technology’s appeal will come in December. Filmmaker James Cameron’s “Avatar,” a sprawling $300 million sci-fi epic meant to showcase the wonders of the technology, should have enough 3-D screens ready for it to be the first wide release 3-D film.

If the movie appeals to a larger audience (most 3-D releases up to this point have been family-oriented) and at least breaks even, expect more 3-D movies geared for all audiences. Many studios are re-mastering older movies for a 3-D release: “Toy Story” and “Toy Story 2” already have done so, and a 3-D re-release for the “Star Wars” movies is also in the works.

Given the high cost of converting theaters, it will be a while before the full 3-D transition is complete. Movie studios are partnering with theater operators to shoulder some of the cost, but it will be at least a year before the conversion process meets up with demand.

Nearly half of the mark-up for 3-D tickets goes to theater operators. When the conversion is complete, the increased take from the box office will go straight to the bottom line for theater operators.

Theater Operator # of Screens Avg. Ticket Price Yield YTD Return
Regal Entertainment (NYSE: RGC) 6,778 $8.17 6.3% +10%
Cinemark Holdings (NYSE: CNK) 4,889 $5.55 6.4% +51%
Carmike Cinemas (Nasdaq: CKEC) 2,286 $6.50 N/A +198%

All of the theater chains in the table above are compelling investments, but one stands out: Cinemark Holdings (NYSE: CNK).

Regal Entertainment (NYSE: RGC) has more theaters and revenue, but Cinemark has more growth potential. Revenue has grown +22.5% in the past two years. Regal’s grew +3.3%.

About 20% of Cinemark’s revenue comes from outside the United States. Regal doesn’t operate any theaters outside of North America. While the U.S. box office struggled to hold ground last year, Latin America’s take grew faster than anywhere in the world. Cinemark operates 128 theaters in the region with more than 1,000 screens, mostly in Brazil and Mexico. The company will likely expand further into this market as it grows.

Cinemark has about 1,500 3-D screens, and many more on the way. The cost to convert a screen to show 3-D may be steep, but the average revenue per screen for the company is $106,000 a year — and 3-D sales can only add to that cash flow.

Cinemark’s average ticket price is $5.55, compared with the national average of about $7, so the company has room to raise prices. With 3-D screens, prices can be raised even more. And while investors wait for a full 3-D rollout, they can enjoy the company’s 6.5% dividend yield in the meantime.