July 18, 2010, 12:20 pm

RLD - RealD

Following piece was done pre-ipo for subscribers. RLD priced strongly at $16 and traded in a $19-$21 range first day. While I liked this deal mid-teens, I am not a buyer at all $20+.

RLD - RealD plans on offering 12.4 million shares (assuming over-allotments) at a range of $13-$15. Insiders will be selling 6.4 million shares in the deal. JP Morgan and Piper Jaffray are leading the deal, William Blain, Weisel, and BMO co-managing. Post-ipo RLD will have 52.5 million shares outstanding for a market cap of $735 million on a pricing of $14. Note that sharecount includes warrants/options given to movie theater chains as incentives to sell-in RLD's 3-D technology. These options are included as an expense item to fair value on the earnings statement. However as they will eventually be converted to shares it is best to remove the expense item and include those in the sharecount instead.

Ipo proceeds will be used to repay debt and for general corporate purposes.

CEO and Chairman of the Board Michael V. Lewis will own 14% of TLD post-ipo. President Joshua Greer will also own 14% of RLD post-ipo.

From the prospectus:

'We are a leading global licensor of stereoscopic (three-dimensional), or 3D, technologies. Our extensive intellectual property portfolio enables a premium 3D viewing experience in the theater, the home and elsewhere.'

The 'Avatar' ipo essentially. Avatar was such a huge 3-D success, film companies all over the world are now planning on filming and/or converting their big releases into 3-D...and RLD is far and away the worldwide leader in movie theater 3-D technology. The Last Airbender was shot in 2-D with no plans on a 3-D release. Post-Avatar, The Last Airbender was converted into 3-D and grossed $70 million total over the July 4th holiday weekend. Only a percentage of that take was from the 3-D screens, still the trend post-Avatar is to now release a 3-D version of a 'big release' movie. The next Spiderman installment for example is now expected to be in 3-D.

Note that there is a big difference from filming 3-D (as Avatar was filmed) and filming in 2-D and converting in post-production. Either way though, the end result is shown in theaters on RLD's 3-D screens.

Our 2nd 'story stock' ipo of the summer here, this one has better financials than TSLA at least...Although it would be quite difficult to have worse financials than TSLA!

RLD licenses their 'RealD Cinema Systems' to theater chains. In addition, RLD sells their 3-D formant, eyewear and display/gaming technologies to consumer electronics manufacturers and contend providers for 3D viewing in high-def TV's, laptops and displays.</p>
In addition RLD's 3D technology has been used in applications such as piloting the Mars Rover, military jet displays and medical procedures.

***Growth has been ridiculously good over the past few years, reaching critical mass in the 12 months ending 3/31/10. As of 3/31/10, RLD's 3-D technology had 5,321 screens, up from 2,108 on 3/31/09. That is a year over year screen growth of 152%. With the sector trends noted above and this sort of year over year growth and clean balance sheet, this is a recommend in range right here. RLD is not just winning the movie 3-D technology battle, they have won the war.

Main competitor is IMAX. IMAX grew to 438 screens in 3/31/10 from 371 in 3/31/09. By all indications, the IMAX experience is more impressive than RLD. RLD has won on installation cost however as retrofitting existing theater's for RLD 3-D is far less expensive than an IMAX installation. RLD has won on cost.

***Note that growth continues. As of 6/30/10, RLD's systems were on 5,966 screens a sequential quarterly rate growth of 12%. RLD screens are in 51 countries with 64% being in the US. </p>
First RLD 3-D release was Disney's Chicken Little in 2005. With that release, RLD became the first company to enable 3D theater screens using digital projection.

Current licensees include the big chains: AMC, Cinemark and Regal. Revenues are generally on a per-admission basis, although RLD does have fixed-fee and per-motion picture contracts as well. Contracts are excluse five year deals with theater chains. RLD has agreements with the three to install RLD systems in an additional 5,100 screens which would push RLD over the 10,000 screen number.

RLD currently has 75% of the domestic 3D box office market. Avatar was released on 4200 RLD enabled screens.</p>
Growth - From 2005 through 2009, 27 3D motion pictures were released. In 2010 alone, 23 3D motion pictures will be released with 33 more expected in 2011.

Competitors include Dolby, Imax Masterimage and Xpand. As noted above, RLD has won the movie theater 3D war, remains to be seen in consumer electronics.


$1 per share net cash post-ipo.

Fiscal year ends 3/31. FY '10 ended 3/31/10.

Product revenues(eyewear) accounted for approximately 55% of revenues, licensing per movie revenues 45%.

Gross margins are negatively impacted by the 3D eyewear. Currently RLD sees a negative net margin on eyewear. in Fy '10 RLD began an eyewear recycling program they hope will lower their costs and push eyewear into positive margin territory. Currently this is an issue however and longer term profitability will in part be determined by RLD's ability to gain some margin traction on their eyewear.

Licensing margins are strong as the costs there are minimal. This part of the revenue stream (55% in FY '10) is similar to the Dolby business model. The technology is already there so the cost to RLD is minimal.

***Note that GAAP earnings for FY '10 and FY '11 have been/and will be skewed by theater stock options. A few years back RLD offered, nearly free, 3.6 million stock options total to AMC, Cinemark and Regal as incentive to grow the installed RLD 3D screen base. Those options fluctuate with the implied price of RLD's stock worth. These options will be exercised once screen targets are achieved, so they belong in the sharecount and not on the earnings statement. Because the implied value of RLD's worth grew so much in FY '10, these options accounted for a GAAP drag of $39 million on net revenues. This was not a real cost and gets folded out and those options get put into the sharecount instead.

The above could be a potential drag on the stock price as those theater chain stock options make it appear as if RLD is much less successful on the bottom line than they really are. To date, all the mainstream press articles on RLD note the losses without noting they come from these external stock options.

Two issues, one real and one a GAAP accounting rule. The real issue is RLD's need to improve margins on their eyewear. The licensing model is raking in the cash on top/bottom line, the eyewear is currently killing margins.

FY '10 (ended 3/31/10) - $189 million in revenues, a massive increase from $45 million in FY '09. Drivers here include 1) an increase in RLD 3D screens, 2) more 3D film releases and 3) the massive success of Avatar. Gross margins were 26%. Again the negative margins on the 3D eyewear are hurting overall gross margins. Operating expenses have grown far slower than overall revenues, a good sign. Operating expense margin was 23%, putting operating margins at a slim 3%. Plugging in taxes puts net margins at 2%. Earnings per share of $0.07.

FY '11(ending 3/31/11) - Very difficult to forecast. By the end of the fiscal year, RLD 3D screens should grow by 50%. Factor in the increased slate of 3D releases and it should be another solid revenue growth year. The question mark however is 'The Avatar Factor'. Avatar accounted for a huge chunk of FY '10 licensing revenues, plus eyewear revenues per attendee. It is doubtful there will be another Avatar like performer in FY '11. Toy Story/Shrek were the drivers in the June quarter, each becoming a big hit. Harry Potter should drive revenues in the December quarter.

I would estimate FY '11 revenues in the $260 million range, approximately a 36% increase from FY '10. As usual, I'd rather be a bit conservative here. FY '10 gross margins were impacted by eyewear recycling start-up costs. Folding those out and including some success in that program in FY '11 should push gross margins to 30%. Operating expense ratio should dip to the 20% area, putting operating margins at 10%. Plugging in taxes puts net margins at 6 1/2%. Earnings per share of $0.32. On a pricing of $14, RLD would trade 44 X's FY '11 earnings.

Again, as noted above, GAAP earnings will be negatively impacted by theater chain stock options. I folded those out and placed those options in the sharecount.

Conclusion - Trends here are about as strong as they come. RLD's 3D technology is the standard and by 2011 they should be in over 10,000 screens. In addition, the major film companies are planning approximately 30 3D releases annually the next couple of years. At a pace of over 1 per every two weeks, it should keep those screens lit. The question mark here is whether RLD can convert this swift growth into bottom line growth/profits. Thus far that has not really happened due to negative eyewear margins, and the risk here is that it never will. Growth and the trends are so strong here though that this is an easy recommend in range.

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