Chinese box office too good to be true

As active investors in public equity markets, we are continually reverse-engineering the expectations built into stock prices and evaluating the reasonableness (or otherwise) of these expectations. Our analytical journey recently led us into the world of Chinese movie cinemas.

IMAX China Holding (HKEx: 1970) is the Chinese majority-owned subsidiary of IMAX Corp in the United States. As we were exploring the depths of the company’s regulatory filings, we found it odd that, in 2014, IMAX Corp valued this business at just US$400 million – while the market was valuing the business at more than 3.5x that amount. Clearly, the market’s expectations for this business had become inflated.

Indeed, by our numbers, with a stock price of around 35 HKD/share, the market was saying that revenues would triple, and earnings would increase by nearly 5x by 2025. To achieve these rates of organic growth, this would have to be one of the greatest businesses of all time.

And while IMAX China had been suffering from IP theft as well as well as competition from domestic studios, it was true that the Chinese cinema industry and box office were growing rapidly. Or was it?

In recent days, the Nikkei Asian Review published a story titled: “Accounting trickery belies magic of Chinese movie revenues” which asserts that government-published box-office revenues are overstated.

“This year, officials started counting in receipts a service fee of 2 yuan to 3 yuan charged by online ticket sellers. But none of this is part of what moviegoers pay to theaters for their tickets — and so by all rights should not be part of total box-office revenues.”

“The government made no mention of the fee when presenting its figure. It even boasted that China now has the most screens of any country, calling the development the driving factor in the rise in receipts. This analysis is misleading at best.

And the market was misled, as evidenced by IMAX China’s inflated stock price – but not anymore. In a matter of months, IMAX China’s stock price halved. By definition, this means the market’s expectations for growth in this business have been tempered. It was always only a matter of time.

Montaka was short the shares of IMAX China Holding (HKEX: 1970) but has since covered its position.

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Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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