Shares of the big-screen cinema technology provider in China dropped about 4% in the three days after it reported a plunge in its first-half profit

Key Takeaways:

  • Imax China barely remained profitable in the first half of 2022 as Omicron outbreaks and resulting control measures led to theater closures
  • The number of Hollywood films released in China has dropped as well, which makes it difficult for theater operators to draw big audiences

By Warren Yang

More than two years into the Covid-19 pandemic, Imax China Holding Inc. (1970.HK) and other movie businesses in the country are still very much haunted by the virus. And even without Covid, life is becoming harder for many as chilly China-U.S. relations make it increasingly difficult to import big-budget Hollywood films to a country vying with the U.S. for the title of the world’s largest move market.

Imax China, a unit of Imax Corp. (IMAX.US) that provides big-screen technologies for movie theaters in China, suffered a net loss in 2020 as Covid-19 outbreaks at the start of the pandemic forced theaters to shut for more than half of the year. Things rebounded somewhat last year as China brought its virus situation under control, drawing consumers back to theaters and helping Imax China return to profitability.

But that recovery proved short-lived as the highly contagious Omicron arrived in various parts of China early this year in a sort of “second act” for the pandemic in the country. That led to fresh lockdowns in major cities like Shanghai, forcing many theaters to close again, dealing a blow to Imax China and the theater owners that are its customers, as reflected in the company’s interim results released last week.

Meanwhile, it’s become increasingly common for Hollywood blockbusters to fail to pass muster in China, often for reasons many believe to be political. For example, Marvel Studios’ “Shang-Chi and the Legend of the Ten Rings” hasn’t been released in China, even though the film was made with the Chinese market in mind due to lead actor Simu Liu’s Chinese heritage and abundant Chinese cultural references. The lack of a release came after some criticism of the movie on social media, and also amid speculation that a comment by Liu about China didn’t go down well with regulators.

Tellingly, the number of Hollywood movies released in Imax’s format in China annually more than halved to 13 last year from 30 as recently as 2019. The tally for the first half of this year was unchanged from the year-ago period at eight.

Imax China’s predicament in the first half of this year is prominently displayed in the latest interim report. Its revenue for the January-June period tumbled about 39% year-on-year to $32.7 million as more than half of the theaters using its products were shut as of the end of March, just before a two-month lockdown of Shanghai began.

During the six months, overall box-office sales in China declined by a similar 38% year-on-year, to $2.6 billion. In a stark contrast, North America’s first-half box office more than tripled to $3.7 billion, as business returned to more normal levels for much of the U.S. and other western countries.

Falling sales were just was one of several problems Imax China had to deal with. Its profit was also eroded by provisions for potentially delinquent receivables due from struggling theater operators, reflecting stress across the film industry. The company also booked an impairment of its investment in “Mozart from Space,” a sci-fi comedy made by actor-turned-director Chen Sicheng, based on its underwhelming box office results and high distribution costs. And last but not least, the company was hit with foreign-exchange losses as the yuan lost value against the U.S. dollar.

Plunging profit

When the final curtain came down, nearly all of Imax China’s net profit was wiped out for the period. The company barely stayed in the black in the first half, recording a net profit of just $766,000, compared to $19 million a year earlier.

Lockdowns and other Covid restrictions on people’s movement are detrimental to any consumer business. Some companies can shield their revenue from disruptions to their physical operations to some extent, for example, by selling takeaway food or boosting online sales. But such options don’t really exist for cinema operators due to their nature as onsite experience providers, making them particularly vulnerable to Covid flare-ups.

One of Imax China’s major revenue sources comes from a cut of ticket sales from users of its technologies. It also leases its systems to theater operators for fees, some of which depend on box office performance. Yet another income stream comes from fees for making and installing projection equipment. And lastly, the company receives fees for providing maintenance services for its equipment in theaters.

Among these income sources, all except for maintenance fees are affected by box office sales and all dropped across the board in the first half.

The second half looks less gloomy now that China has begun to reopen with its Covid situation improving. About 90% of the country’s Imax theaters were open at the end of June, though at varying capacity.

But major uncertainties remain that could still spoil the show. A resurgence of Covid cases and return of lockdowns can’t be ruled out as Beijing sticks to its “zero Covid” policy. And with China’s economic growth slumping, consumers may grow more reluctant to spend on unessential items like movie tickets.

Investors apparently weren’t impressed with Imax China’s latest results, sending its shares down by nearly 4% in the three days after it reported the earnings, though the stock gained some of that back on Wednesday. With the drop, the stock has lost nearly 80% of the price it fetched from its 2015 IPO.

Still, Imax China has been faring better than other cinema-related companies. Its Imax Corp. parent was unprofitable last year and remained so through the first quarter, though it turned profitable in the April-June period as theaters in its primary western markets reopened. And it’s a similar story for U.S. theater operator AMC Entertainment (AMC.US).

Imax China stock trades at a trailing price-to-earnings (P/E) ratio of about 7.9, not bad for this kind of relatively slow-growth company. But its price-to-sales (P/S) ratio is 2.6, below the 3.8 for its parent and 3.5 for AMC. Imax China’s valuation indicates that while investors haven’t turned their backs on the company, they remain somewhat cautious. Such wariness is well justified in light of the company’s exposure to pandemic disruptions and political tensions between Beijing and Washington.

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