NOTE: this posting was slightly delayed because we were busy last week in connection with NAB.
On April 9, 2010, 3D technology company RealD Inc. filed an S-1 registration statement for an IPO. This is our second post this week on IPO’s. That is some coincidence, but it also reflects the fact that the IPO pipeline is the strongest it has been since before the financial crisis. A select group of entrepreneurs should be paying attention. As a service to our dear readers we thought we would provide summary and perspective on RealD’s filing.
RealD’s business is growing nicely. RealD generates substantially all of its income by enabling 3D viewing of motion pictures in theaters, both installing 3D projection equipment and providing eyeglasses for viewers. As of March 26, 2010, the company had its proprietary technology installed in 5,321 digital theaters. This number is up 152% from 2,108 screens in March 2009. Further, the company is working to install another 4,900 screens pursuant to agreements with existing licensees.
The Company is aligned with Digital Cinema Implementation Partners (DCIP). The three exhibitor co-owners of DCIP – AMC, Cinemark and Regal – are all licensees of RealD. Given that DCIP completed $660 million in financing in March to continue its digital cinema deployment, that roll-out should give RealD a tailwind of new theaters to support. DCIP’s financing will fund the digital deployment of approximately 14,000 screens. RealD’s exhibitors also have penny warrants equal to 8.9% of the Company’s pre-IPO shares – while no individual warrantholder reaches the 5% threshold required for disclosure in the S-1, it is safe to assume that the DCIP owners hold a chunk of these warrants.
The Company has recently valued its equity at $578 million. Other than paying a registration fee to the SEC for aggregate IPO proceeds of up to $200 million, neither the Company nor the underwriters (JPMorgan and Piper Jaffrey) take a view on RealD’s IPO value. However, for accounting purposes the Company is required to value its exhibitor warrants as they vest, because the value of such warrants must be deducted from revenue (as if they were a sales allowance, which in a way they are). In December 2009, the Company estimated the fair value of its common stock to be $21 per share, which suggests a pre-IPO equity valuation of $578 million.
RealD’s business model is a direct play on the commercial success of 3D. RealD is definitely eating its own cooking. By the terms of the majority of its exhibitor deals, RealD buys and installs the necessary equipment at the exhibitor, and then collects a per-attendee fee from the exhibitor. The exhibitor thus takes limited risk (they are giving RealD some exclusivity), while RealD has a business model with some capital intensity (they buy and install the equipment up front) but high margins on incremental revenue. So…
RealD should be marketing its IPO on a terrific March 2010 quarter. Because of RealD’s business model as noted above, the March quarter should be strong. Avatar was released 12/18/2009 and rolled well into Q1, and Alice in Wonderland was released 3/5/2010. Those two smashes alone should give the company continued strong growth.
RealD’s bet on 3D is a slightly different play than, for example, Cinedigm’s (NASDAQ: CIDM) economics on digital cinema. Cinedigm gets a “virtual print fee” from a studio every time it delivers a digital movie file to a screen. Oddly, Cinedigm’s revenue goes up with the velocity of movies delivered, not how long they stay in theaters. So for example, Avatar’s long run in Q1 will modestly depress Cinedigm’s results, while the big Avatar gate will favorably affect RealD’s. That difference works both ways, a quarter of weak releases will probably help CIDM and hurt RLD.
It’s the glasses, stupid. Currently, RealD’s income statement is dominated by eyeglass sales, not exhibitor licensing. For the nine months ended December 2009, gross licensing revenue was $44.4 million while product sales (eyeglasses) were $68.4 million. The licensing business is highly profitable on a stand-alone basis, but the gross margin on eyeglass sales is currently negative (RealD lost $9.2 million on its eyeglass sales).
RealD is handling eyeglasses differently in North America and overseas. In North America, it is receiving a per-admission eyeglasses fee from the exhibitor, and is assuming that eyeglasses last eight weeks for the purposes of amortizing their cost. Overseas, RealD is selling the glasses outright. As anybody who has seen a 3D movie knows, the glasses are a logistical challenge for the exhibitor, and Joe Morgenstern at the Wall Street Journal has written about the quality issues with 3D glasses (subscription required). RealD is working to increase recycling of glasses and generally to reduce their cost. In the long term, this logistical challenge is probably second only to the success of 3D generally in determining the long-term profitability of the company.
3D in the home – just starting. The Company is working to license its 3D technology to consumer electronics manufacturers, and also has 3D technologies on the way which do not require eyeglasses. However, these initiatives do not yet have any impact on the Company’s revenue and near-term prospects. This IPO will be bought and sold largely on the prospects for theatrically released 3D content and RealD’s competitive position.
Stay tuned for updates as the IPO proceeds!