Imax Looks to Reel In Investors

This alert was originally sent to subscribers of TheStreet.com's Stocks Under $10 on Sept. 28 at 9:59 a.m. EDT and is being reprinted here as a special bonus for TheStreet.com readers.

We are initiating a 300-share position in Imax (IMAX Quote) with shares trading at $9.36. We believe this Stealth Stock has double-digit percent upside from the current quote given a handful of potential catalysts between now and year-end.

With the pressure on theater operators like AMC to get people off the couch and into theaters, we believe Imax, a large-format movie operator, is a compelling investment idea. If Imax sounds familiar, it may be because we held a position in the stock for much of the past year. We closed out the final position for a 29% gain in mid-August, when shares were trading about 10% higher than the current quote.

Imax's 100-foot-wide screens, 12,000-watt sound systems and patented MPX projection systems transform standard multiplex cinemas into a virtual reality-like experience. Best yet for ailing theater operators, it takes only a matter of months to convert a regular theater into an Imax one.

There is clear evidence that Imax generates strong returns for theater operators and movie production companies. The 2004 holiday blockbuster "Polar Express" was simultaneously released in both standard 4/35 film format (4 perforations high and 35 millimeters wide) and Imax's patented 15/70 format (15 perforations high and 70 millimeters wide). On Imax screens, "Polar Express" generated sales in excess of $40 million, or 22% of the total box office proceeds, despite Imax being just 2.5% of the screens that showed the movie. More recently, the first weekend-per-screen average sales of "Charlie and the Chocolate Factory" on Imax screens were nearly twice that of standard theaters.

For the remainder of 2005, Imax has an impressive film lineup that should provide a nice backdrop for the stock to outperform. This fall, Imax and Warner Brothers will simultaneously release the next Harry Potter film, "Harry Potter and the Goblet of Fire." If the last Harry Potter film, "Harry Potter and the Prisoner of Azkaban," which grossed $250 million on Imax and standard screens in the U.S., is any indication of what we can expect in the coming months, there could be plenty of positive news coverage for Imax. Also, Imax will re-release "Polar Express," which we believe will attract repeat customers and keep the seats in Imax theaters filled until the 2006 lineup is launched.

In May, Imax announced a pretty significant breakthrough when it signed a deal with AMC, the second-largest theater operator in the U.S. The deal calls for five AMC theaters to be converted into Imax MPX theaters. Imax expects the theaters to be up and running in time for the release of the Harry Potter movie in November. We believe the AMC deal will help further prove that conventional theaters adopting Imax's MPX system will generate significant returns, and lead to more Imax deals with domestic theater operators.

But even without those additional theaters, Imax's top- and bottom-line results in the first half of this year were impressive. For the first six months, Imax reported sales of $62.3 million and earnings of 4 cents a share, vs. $55.6 million and break-even bottom-line results in the first half of 2004. Results in the second half of this year should be even better, with the Street forecasting 13% year-over-year sales growth and 50% earnings growth.

We believe the downside risk from the current quote is limited due to the stock's attractive valuation of just 25 times earnings estimates compared with analysts' expected bottom-line growth rate of 50%. With that in mind, we will consider using weakness under $8.50 a share to add to our position.