The costly settlement of the Hollywood actor’s strike and the lacklustre box-office performance of several would-be blockbusters this year suggest the entertainment industry may be facing a period of challenge rivaled only by the advent of talkies in the late 1920s.
During that period of transition, studios had to adopt the new technology of sound and contend with the economic effects of the Great Depression and new censorship laws. Yet the industry met those challenges and entered the Golden Age of Hollywood.
Will the challenges be met this time around? Don’t count on it. Investors would be wise to stay clear of the bright lights of Tinseltown for the foreseeable future.
Companies such as Disney DIS-N, Warner Brothers WBD-Q and Paramount PARA-Q have seen their stock prices roughly cut in half from their peaks reached in the past few years. Studios and streaming services are for the most part bleeding cash, as film after film loses money. For streamers, subscriber growth is dramatically below management expectations.
Entertainment stocks soared during the lockdowns as investors believed people would remain home and consume endless amounts of streaming service content. Movie theatre companies like AMC AMC-N and Cineplex CGX-T were already in a difficult environment even before the pandemic hit.
The long-term stock charts of companies in the entertainment space look like a classic bubble followed by a bust. All bubbles do eventually burst and Hollywood’s, to its credit, lasted longer than almost any. However, an examination of financial metrics indicates that the industry had been in a classic maturation phase for two decades. Industries typically have a life cycle from birth to commoditization. And while revenues continued to grow for years because the annual increase in ticket prices more than offset declining tickets sales, this trend has now ended. The industry is now faced with a perfect storm of declining revenues and exploding costs.
Disney stock was going for around US$16 in early 2009. The stock had traded in a narrow range for the next several years, and was largely considered a blue-chip – solid, dependable, but unexciting. But by March, 2021, it rocketed to almost US$200 amid speculation that the entire world would be locked inside their homes indefinitely watching live action remakes of old animated movies. Since that time, the stock has been sliding, and currently sits around US$90.
Which of these eight Canadian entertainment stocks are undervalued?
The entertainment industry is simply oversaturated, especially when you consider that growth in movie ticket sales petered out in 2009. That year in the television business, about 200 series were produced. In 2022, about 600 series were produced. The growth may seem understandable given streaming services and the fact that the consumer, thanks to smartphones, tablets and other devices, have more opportunities to watch content. But this only works if audiences continue to snap up content at a voracious pace while the content producers keep costs low.
Production costs have soared to the point of making most big-budget movies a money-losing proposition. Too many have budgets that are too big. Yes, movies like Barbie and Oppenheimer were huge hits, but an unending number of movies like The Marvels, The Flash, Mission Impossible 7, Fast & Furious 10, Strange World and others have posted nine-figure losses.
For a movie to break-even, it must make almost three times its production costs at the box office. For example, let’s look at Disney’s recent film The Marvels. The film cost, according to Wikipedia, about US$275-million to produce; US$220-million after tax incentives. Marketing costs are usually another 50 per cent to 100 per cent, bringing the total cost to a minimum of US$350-million. Given that the theatre takes about 50 per cent of the revenue from ticket sales, The Marvels needs to gross US$700-million to break even. The film will not get anywhere close to that. In fact, in any given year, few movies take in more than US$500-million at the box office.
Even streaming has not been the cash cow some expected it to be. Many services are bleeding cash or are not very profitable. Netflix is unique and is a brand name with a large subscriber base. It is also not beholden to one studio and imports popular productions from all over the world from countries that can make content for less than North American producers. I expect mergers in the streaming market to occur and that makes economic sense.
Until the entertainment industry figures out how to turn around the present situation, stay clear. Some stocks may look cheap, but beware – that could be for a good reason.
Theatre stocks are probably too high-risk right now – the film releases slated for the next six months to two years look like they aren’t going to do well, based on feedback from test audiences.
Warner and Paramount stocks and balance sheets are challenged. Netflix as a business looks solid but at a P/E of 46, the market is discounting a large rise in earnings.
Comcast CCZ-N has cable and a diversified portfolio and trades at under 12. It may be a decent candidate just because it’s cheap and its holdings go well beyond the entertainment industry. But there are certainly risks.
If the industry learns how to make successful movies for under US$100-million and streaming services consolidate and allow advertising, the good times can return.
Right now, they are simply inefficient. Producers need to be more effective as managers. Directors need to be better at filming on budget and on schedule. Artificial intelligence may play a greater role some day, but we are a long way from it having a significant impact on costs.
In 1964, the film Mary Poppins was produced for about US$6-million or US$60-million in current dollars. It grossed $1-billion in current dollars – and it had dancing penguins.
Tom Czitron is a former portfolio manager with more than four decades of investment experience, particularly in fixed income and asset mix strategy. He is a former lead manager of Royal Bank of Canada’s main bond fund.
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