External Assessment
This analysis examines the film industry, including photographic equipment, supplies, and motion picture production and distribution, which relates to the entertainment sector.
Opportunity: Growing demand for large-scale 2D/3D film viewing experiences. Evidence includes increasing order trends for 3D systems and pricing trends show consumers are willing to pay a premium price for these enhanced movie experiences. The strategic group this affects is the large format film group. Key success factors include supporting research and development for new advanced technology and having expertise to build and service the relevant equipment.
Threat: The threat of substitutes coming from new technological advancements that allow alternative viewing choices which include, but are not limited to, home theatres, internet viewing, VOD, etc. Evidence shows that currently 85 per cent of a film’s revenue is attributed to home viewing and the prevalence of film piracy is increasing as a result of the internet. The strategic groups this effects are those involved in the distribution channels of films. Key success factors include government support through copyright laws protecting film distribution and the ability to capitalize on technological and environmental assets to provide consumers with a unique social experience that cannot be replicated at home.
Opportunity: Growth in emerging international markets, particularly the Asia-Pacific region. Evidence shows that a significant amount of a film’s revenue now comes from outside the U.S. and globalization and increased movement of people crossing national borders. The strategic group this affects is the international visual entertainment group. Key success factors include international service, support, and distribution networks; as well as global partnerships linking production and distribution. (Please see Exhibit 1)
Internal Assessment
IMAX is involved in long-term theatre system leases, maintenance agreements, film production and distribution, and theatre operations; providing large-film format 2D/3D movie experiences.
Resource: Technology protected by 46 patents and 7 pending patents in the U.S. This resource is valuable because it enables IMAX to exploit opportunities created by growing demand for large-scale 2D/3D viewing and lawfully neutralizes the threat of rivalry and imitation. It is rare because, by definition, no other firm have these patents. Competitors face a cost disadvantage because they have to purchase/lease IMAX’s protected technology. IMAX has and uses the complementary resources (partnerships, theatres) necessary to exploit this technology. This creates a sustained competitive advantage and is a sustained distinctive competency for IMAX.
Capability: Partnerships and lease agreements with rival theatre operators (Regal Cinemas, AMC, etc.). This resource is valuable because it enables IMAX to expand into emerging markets and neutralizes the threat of rivalry. It is rare because IMAX signed exclusive agreements with these firms. Competitors face a cost disadvantage because partnerships reduce IMAX’s capital requirements. IMAX’s co-CEO’s support such partnerships and views them long-term opportunities to expand, which creates a sustained competitive advantage and sustained distinctive competency for the firm.
Capability: Partnerships with rival film production and distribution studios (Disney/Pixar, Time-Warner, etc.). This resource is valuable because it allows IMAX to reach emerging markets and increase barriers to entry for the industry. Currently there are no other firms converting Hollywood movies into 2D/3D large-screen format. It is imitable should another firm gain IMAX’s film conversion technology once patents expire. These partnerships are supported by IMAX’s co-CEO’s, creating a temporary competitive advantage. (Please see Exhibit 2)
Financial Assessment
In 2004 and 2005 IMAX was a company on the rise. With an ROIC ratio of 0.0724 up from 0.0547 and a current ratio of 2.4781 in 2005, IMAX was more than able to meet their current liability commitments. Things changed in 2006 when the company failed to turn a profit, which is a result of decisions made in 2005. In 2005 IMAX employed a selling strategy that resulted in selling theater equipment to buyers with lower credit. This strategy incurred a high A/R in 2005, which had to be overturned in 2006. In 2007 IMAX continued to struggle as a result of the 2005 selling strategy; the high write-off of A/R in 2006 caused higher debt levels compared to current assets. IMAX’s ability to pay off current liabilities fell to 0.8973 and its ability to pay off interest was -0.6656. These ratios show that IMAX is at risk of defaulting on its debt. In the past two years IMAX has not made enough profit to cover the interest on its debt which signals significant problems. IMAX has a huge debt problem, but the future is potentially promising. At the end of 2007, IMAX signed a deal with AMC to supply 100 theaters with the IMAX system and they also signed a deal with Regal Cinemas for 38 new theater systems to be installed by 2010. These partnerships with renowned theatre-owners signal that IMAX has the potential to increase revenues and emerge from its current debt problem. The deal with AMC allows IMAX to reduce its debt by lowering its capital requirements and to benefit from revenue-sharing on ticket sales.
Throughout IMAX’s history, R&D has been a source of differentiation for the company despite debt issues. This positions IMAX out of debt struggles because their 3D technology allows them to charge a premium at the box office; their digital conversion technology enables IMAX to convert Hollywood films into large screen format. This reduces their need to invest in movie production while expanding their core audience. (Please see Exhibit 3)
Assumptions & Justifications
The assumption for the increase in revenue was 10 per cent annually until 2012 and 8 per cent after that. This was assumed because IMAX signed new deals with AMC and Regal for IMAX systems projectors. These new deals should prompt more theater system deals and partnerships for IMAX in the coming years The assumption for direct operating expenses, general administration, and other expenses is that it will increase by 3 per cent annually till 2012 and 2.5 per cent after that. This is because the capital cost of digital equipment is lower than non-digital equipment so IMAX’s operating expenses will be reduced throughout the conversion process. It is also assumed that IMAX will continue to keep Research and Development spending at the 2007 level but increase their sales and service force, as there are more theaters to service with these new deals. Depreciation will stay at the 2007 level for the next five years because no significant equipment expenditures will be undertaken considering current debt levels. Interest will stay the same because IMAX will not incur more debt and will not pay off any of their debt for the next 5 years. Capital expenditures will grow 4 per cent for the next two years and then stay constant at the 2009 level because the new agreements will require new instillations for many theaters and IMAX will need to manufacture more equipment up front. The discount factor was assumed to be 15 per cent and the expected growth rate 10 per cent. Five per cent was used to discount the terminal value based on the 2012 free cash flow amount.
NPV Analysis
The NPV for the most likely scenario is $19,127,000. Under the Optimistic scenario the NPV is $221,823,000, this is because of a 12 per cent increase in revenue prediction compared with a 10 per cent increase in revenue with the most likely scenario. The optimistic scenario has an expected growth rate of 10.25 per cent compared with a 10 per cent expected growth rate for the most likely and pessimistic scenario. These changes resulted in a difference between the optimistic and most likely scenario of $104,696,000. The NPV under the pessimistic scenario is -$45,194,000 this change is due to an estimated increase in revenues of 7 per cent and an increase in the cost of operations at 5 per cent compared with the most likely scenario at 3 per cent. These changes resulted in a difference between the most likely and the pessimistic scenario of $64,321,000. (Please refer to Exhibits 4A, 4B, 4C)