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August 16, 2007

International Box Office Strength

One of the things I have not stressed enough in my comments on the box office has been the strength of the international box office. According to Variety.com's international weekend wrap-up, the non-US box office is up 20% year-to-day with summer gains exceeding those of the US. Unlike my domestic box office commentary which focuses on the impact on US theatre exhibitors like Regal Entertainment (RGC) and Cinemark Holdings (CNK), for investors, the international box office is important for the studios that produce and market the films. The top studios are owned by News Corporation, Disney, Viacom, Sony, General Electric, and Time Warner.

The reason the international box office matters is because of the well known escalation in the cost of producing and marketing films. Most major releases cost at least $100 million to produce and market and it is not unusual for these costs to balloon to $250-300 million or more. This data is not readily available and what data exists probably understates the true costs.

Strength in international box office accrues to the benefit of the studios by helping to cover the production and marketing costs with box office receipts (the holy grail of Hollywood!) and providing revenue from sale of DVDs, sales and licensing of merchandise, and the sale of international broadcast and pay TV rights.

According to data at BoxOfficeMojo.com, the international box office has risen from $4.4 billion in 2000 to $9.6 billion in 2006, a CAGR of 14%. During this same time frame, the domestic box office has risen from $7.7 billion to $9.2 billion, a CAGR of just 3%. Looked at another way, international box office was 36% of the total global box office in 2000 but had risen to 51% in 2000.

The growth in the international box office has come from a variety of factors. Economic growth abroad and rising living standards has led to greater consumption of movies in many countries. Distributors have responded by investing in new theatres around the globe including the multiplexes with stadium seating common to the US. Greater marketing emphasis has been placed abroad to tap new markets and films have been produced with international audiences in mind (witness the use of Asian, African, and European pirates in this year's release of Pirates of the Caribbean: At World's End. Local productions have also helped with thriving movie studios existing not just in mature markets like Germany but in emerging markets like Romania....

As with the US market, quality product that interests moviegoers is necessary to drive year-over-year gains. This will become more important abroad as more markets mature. Nevertheless, just as the hype that domestic box office is dead has been put to rest by back-to-back years of strong growth and the soon-to-be all-time record summer of 2007, the idea that the movie studios are in a hopeless situation against rising production and marketing costs and weak domestic growth is a myth that that does not hold up to scrutiny.

Unfortunately for investors, the major studios are small parts of large corporations so growth in the global box office is not something for which direct investments are available. That said, the studios can drive year-to-year results at individual studios which do materially impact earnings and cash flows at individual companies. The success of Disney over the past few years with the Pirates of the Caribbean series, the first picture in the The Chronicles of Narnia franchise, and the Pixar films has been partially responsible for the multiyear double digit operating income growth the whole company has enjoyed. News Corporation's 20th Century Fox studio has alos enjoyed a great multi-year run. On the flip side, a string of poorly received films from Viacom's Paramount studio and Time Warner's Warner Brothers and New Line studios has severely penalized earnings at their parents.

But now Paramount and Warner Brothers are back, ranking #1 and #2 in year-to-date domestic box office. At the a same time, growth is stalling at the Disney and News Corporation where even many successful films in 2007 and 2008 won’t be enough to drive significant growth in their studio segments in this year and next.

Despite the tough comps faced by Disney and News Corporation studios, I still favor these two stocks among the large cap diversified entertainment companies due to continuing to ability to produce double digit operating income growth from other divisions and the most advanced digital and online strategies. That said, decelerating momentum is a tough sell to investors and laggards like Time Warner and Viacom may enjoy accelerating growth thanks in part to their movie studios and the growth of the international box office. That is worth keeping an eye on when evaluating how to allocate your money among the major media stocks.

Posted by Steve Birenberg at August 16, 2007 02:36 PM in Box Office