DEEP INSIGHTS: Movie Rental and Exhibitor Business Update

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

This biweekly newsletter lists key events in the movie rental and exhibition industries for the period between August 13 and August 26, including notable rental releases, box office figures and recent company-specific news.

Movie Rental Industry

Key Redbox releases this year (with domestic box office total in millions from www.boxofficemojo.com):

o 8/14: Sherlock Holmes: A Game of Shadows ($187).

o 8/21: Hunger Games ($405) (NYSE:LGF), The Dictator ($59), Silent House ($13).

Key Redbox releases last year* (with domestic box office total in millions from www.boxofficemojo.com):

o 8/16: Priest ($29), The Conspirator ($12), Hoodwinked Too: Hood vs. Evil ($10).

o 8/23: No notable releases.

*estimated release date

Over the next two weeks, there are two notable rental releases compared to two last year, classifying notable releases as those that grossed over $50 million in domestic box office. We expect the upcoming two-week period to outperform the same period last year, as The Lorax ($214 million in domestic box office) will likely outperform last year’s comparable release Rio ($144 million in domestic box office). Also, Think Like a Man outperformed last year’s Madea’s Big Happy Family.

On August 13, Coinstar (NASDAQ:CSTR) announced that Gregg Kaplan, founder and president of Redbox, will resign to pursue new opportunities. Anne Saunders, Mr. Kaplan’s replacement as president of Redbox, will assume the role effective August 27. We don’t know Ms. Saunders, so we cannot say whether she will have a positive impact on Redbox. We note that Coinstar’s most recent earnings were mixed. Coinstar raised FY:12 guidance $0.10 on the high end net of a $0.40 – 0.50 impact from its NCR acquisition. Unfortunately, the NCR impact was somewhat confusing, and guidance implies that earnings will decline sequentially each quarter this year, sending Coinstar shares sharply lower after its report. We continue to expect CSTR shares to trade in a narrow range until pricing and features for Redbox’s JV with Verizon are revealed, expected some time in the next month.

On August 14, Netflix (NASDAQ:NFLX) announced that it will launch in Norway, Denmark, Sweden and Finland in late 2012. We expect the Nordic launch will lead to a Q4 loss, in line with guidance, given marketing expenses and associated content costs. The Nordic launch will likely have a limited impact on top-line growth in the near term due to a stronger affinity for localized content, particularly movies, than in Canada, and a smaller population (≈ 25 million) than Latin America and the British Isles. We expect shares to continue to trend down, as we believe investors disappointed in Q2 domestic subscriber additions will again be disappointed in 2H domestic subscriber additions given unrealistic guidance. In our view, consensus estimates remain too high.

Exhibitor Industry

Domestic box office was down 7.5% in July. According to boxofficemojo.com, domestic box office results for July declined 7.5%, beginning well with late June releases performing above expectations, including Ted, which earned $157 million in July, Brave (NYSE:DIS) ($98 million in July) and Magic Mike ($78 million in July). Early July releases performed in line with expectations, including The Amazing Spider-Man ($244 million) released on July 3, and Ice Age: Continental Drift ($119 million) released on July 13.

The Dark Knight Rises (NYSE:TWX) was the standout summer blockbuster as expected, but its success has been somewhat muted after the tragic events on its opening night. While we acknowledge the Colorado incident has certainly had an impact on ticket sales for TDKR, we believe that its box office run has been longer as a result. Still, we believe a large number of moviegoers are content to watch in the safety of their homes during the rental window, in which case Redbox will be a clear beneficiary.

August month-to-date is trending down 7.5% due to cannibalization from the Olympics and a generally weak August box office. We had expected moviegoers to head back to the theaters in droves after the Olympics had concluded. However, the muted response to recent new releases indicates that moviegoers are content to wait for more compelling fare. In particular, August action remakes and sequels such as Total Recall, The Bourne Legacy and Expendables 2 all opened below expectations.

Quarter-to-date domestic box office is trending down 6.3%, and our confidence that it will progressively improve over the remainder of the quarter is waning. We expected that after the Olympics, pent up demand would drive higher receipts. However, late August releases have been weak and expectations for September releases have come down. It now appears that our expectation for Q3 box office of up 1.2% is bullish, and will likely trend closer to down 7%. Should August and September continue on the current trajectory, we will revisit our Q3 estimates for our covered exhibitors.

Michael Pachter is an analyst at Wedbush Securities.