Carmike Cinemas (CKEC) was first to reveal the wounds of a business model that can inflict pain as well as pleasure when movie costs rise higher than expected. Columbus, Ga.-based Carmike shares fell 8.5% on Tuesday to $23.84 after reporting profit that fell short of Wall Street estimates, 36 cents per share versus 54 cents per share. Shares are currently down 1.2% to $23.82.
While theaters welcomed a boom in second-quarter revenue thanks to blockbusters Jurassic World, Furious 7 and Avengers: Age of Ultron, the success of those films actually pinched profits.
That's because content fees paid to the studios rise as a percentage of sales as films do better at the box office, said J.P.Morgan analyst Townsend Buckles in a July 22 note. So those top three films, which drew 43% of second-quarter sales versus the top three films in the same quarter in 2014 that accounted for 24% of receipts, actually reduced profits for the theaters.
"The best scenario for a theater is a deep slate of $100 million to $200 million films rather than a few $300 million-plus titles driving business," Buckles said.
Analyst Richard Tullo, director of research at Albert Fried & Company, says if theaters can play the anticipated success of Star Wars correctly -- namely, passing off added licensing costs to customers -- they will likely stave off profit declines. But he cautioned that theaters are grappling with a larger dilemma of increased competition from other movie sources including Netflix (NFLX - Get Report) or on-demand cable on larger home television screens that create a theater-like experience.
"If I'm paying $8.99 for Netflix and buying movies online with the cable systems, that disrupts the movie theater business. It's creating competition for the content on one end, and on the back end it's eroding the theater audience," said Tullo. He said theaters may eventually be forced to explore alternative revenue streams such as hosting movie festivals.
Aside from Carmike's disappointing numbers, AMC Entertainment Holdings (AMC - Get Report) reports today, Regal Entertainment Group (RGC) reports Thursday and Cinemark (CNK - Get Report) reports Aug. 6. Shares of all three closed lower Tuesday, although Regal and Cinemark are trading slightly higher Wednesday.
Tullo said the business model of theaters is headed toward a fate similar to that of newspapers, in that they are increasingly dependent on preserving their current customer base as costs increase and profits decline. "The price of the content is increasing. The industry last year made record revenue, but they had record costs and lower attendance.... and that's problematic," he said.
Compounding the fact that higher film success means a higher percentage of fees to Hollywood, theaters in the second quarter were also hit with the costs of licensing for the 3-D and IMAX versions of Jurassic World, Furious 7 and Avengers: Age of Ultron, which are more expensive than traditional movie formats, said B. Riley analyst Eric Wold.
"While the industry benefited from higher year-over-year box office revenue, that revenue was generated by films that generated lower-than-average margin percentages," Wold said in an email. B. Riley has a buy rating on Carmike, but lowered its price target to $35 from $39.50 Tuesday. "This will always vary quarter to quarter depending on the film slate, but it was just overly impactful this past quarter."
Wold said he expects AMC, like Carmike, to have experienced margin pressures even with positive box office performance, and he expects an overall industry rebound later this year as "industry growth trends remain healthy."
AMC announced on July 14 plans to acquire Starplex and its 33 theaters and 346 screens for $172 million in cash and the acquisition has not yet closed.