Thesis
Helios and Matheson Analytics (HMNY), better known as the majority owner of MoviePass, reported first quarter results which showed a profit. Is this real? Does this mean that they are finally on their way to profitability? I show why you shouldnt fall for fake profits and why even when using the most rosiest of rosiest of assumptions, this is still a conviction short.
Did you fall for the accounting trick?
HMNY reported Q1 numbers which absolutely crushed estimates, with $0.09 EPS beating consensus estimates of -$1.38. Annualized, this would be EPS of $0.36, putting their stock at a P/E of just under 2. For a stock growing subscribers at an obscene rate, at first glance this screams deep value. Lets however set the record straight.
When looking at their income statement, we can see a line titled Change in fair market value warrant liabilities of $93,608,200.
(Emphasis by Author, 2018 Q1 10-Q)
This huge number helped swing their results from deep negatives to the positive territory.
What is this?
Cash flow doesnt lie
We can see in the statement of cash flows that this is really a one time adjustment as it does not show up as cash and is subtracted out to arrive at cash from operations:
(Emphasis by Author, 2018 Q1 10-Q)
Why the warrants were adjusted
On another page in their report they explain that they value their warrants using a Monte Carlo algorithm:
(Emphasis by Author, 2018 Q1 10-Q)
The key points are highlighted: note how the original $14.31 warrants have been completely written off. The reason for the one time write off is now painfully obvious: because the stock price has fallen so dramatically, many of their previously issued warrants have become virtually worthless.
Bottomline: they did not receive any cash for the adjustment to their warrants and thus these are hiding the real cash flow burn of over $68 million in the latest quarter.
Valuation
As of April, before they announced that they would be aggressively using their at the money program and causing their stock to fall through the floor, HMNY had 53 million shares outstanding. With the shares trading around 60 cents a share, some may think that this is cheap. This would imply a market capitalization of $31.8 million. But is it really? Let me show my back of the envelope calculation to show why this may still be way overvalued, even using incredibly optimistic assumptions.
Estimating future costs
HMNY reported $47 million in subscription revenue in the last quarter alongside $136 million in cost of revenues. This implies that for each dollar of subscriptions, they spent $2.88. Their subscription revenues monthly vary from $7 and $10 so lets use $9 to be optimistic and assume movie tickets cost $10. This implies that their subscribers are seeing 2.6 movies per month for a cash deficit of $17 per subscriber per month. Now that we have a good estimate for the net cash deficit per subscriber (and thus how much future dilution to expect) we can start to estimate the future valuation.
Even under optimistic assumptions, this isnt cheap
First, lets estimate the cost needed to attain ten million subscribers, upon which we will generously assume that they will reach the critical mass needed to negotiate the optimistic concessions discussed later.
Lets assume that subscribers grow at 15% monthly, which would be in line with managements guidance to add 2.5 million subscribers by the end of this year. Further, lets assume that once they reach five million subscribers they start to receive concessions of $3 per ticket, all the way to our magic ten million number. The results are seen below:
(Chart by Author)
We can see that they will need approximately $700 million more in funding to reach ten million subscribers. From a current base of $30 million, this will prove no easy feat and will put significant selling pressure on the stock. After all, they would be selling over 23 times that much in market cap. Now that we know how much dilution is needed before ten million subscribers, lets estimate their maximum profit per subscriber (assuming they can suddenly reach maximum profitability at this point).
Understand their ceiling
When trying to estimate their maximum profit potential, we need to keep our estimates reasonable. For one, we should not expect theaters to willingly operate at a loss – thus the absolute maximum concessions that the theaters could give to HMNY is the net profit on their tickets and concessions. All the three major theaters AMC (AMC), Regal (RGC), and Cinemark (CNK) have similar margin numbers. We will use AMC specifically as an example. At AMC, their gross margins on tickets was about 50% and gross margins on concessions around 85% (we will use 90%). Further, the average concessions per viewer was 50% of admissions revenue:
(Emphasis by Author, AMC 2017 10-K)
Using these numbers, we can estimate that, assuming 2.6 movies monthly at $10 per ticket per subscriber, movie theaters could give a maximum of $13 from tickets and $11.70 from concessions (before accounting for operating expenses). Remember, this is assuming that 100% of gross profits from tickets and concessions are distributed from the theaters to HMNY. In this scenario, HMNY would receive $24.70 from the theaters plus $9 monthly in subscriptions from their subscribers. This leads to a net gain of $7.70 per subscriber per month. However, this is extremely unreasonable because in this scenario theaters would be unable to stay in operations as we have not accounted for operating expenses. Together, operating expenses and rent were about 50% of total revenues:
(Emphasis by Author, AMC 2017 10-K)
Taken in full, this would take away $19 of concessions bringing the net deficit per subscriber to -$11.30. I take this opportunity to add that we are ignoring interest expenses for the theaters (again with the intent of being generous).
Now lets drop their expenses by 50% (since we are already in the spirit of unrealistic projections). The deficit is now at $1.35. Lets add more magic and assume that HMNY can get the film companies to even subsidize 10% of each ticket price. Recall that the film companies are getting about 50% of ticketing revenues, which means that the film companies would be giving up 20% of their cut of revenues. This brings in another $2.6 in cash flow to arrive at $1.25 in net cash flow per subscriber, per month.
At 10 million subscribers this would imply $12.5 million in monthly income and $150 million in annual income, assuming no other operating expenses at HMNY. Based on our implied total market capitalization ending June 2019, we could see that HMNY would trade just under 5 times next years earnings. If these were earnings using realistic assumptions, then this absolutely represents real value. But because we arrived at this valuation while using the maximum back of the envelope projections, this is a very poor potential return for a stock which is still struggling to even stay in business. Remember that this is also an essential ceiling on their earnings because they are unlikely to gain more than ten million subscribers, considering only 36 million people in the North Americas even see one movie per month, let alone want to see more than that.
Summarizing the assumptions
Now lets emphasize the key unreasonable assumptions being made in this estimation:
HMNY is able to maintain an aggressive 15% monthly subscriber growth rate all the way to ten million subscribers. Any slowdown in the growth rate would increase the financing needed.
HMNY starts to receive $3 per ticket sold in concessions starting at 5 million subscribers.
HMNY is able to reach maximum profitability per subscriber once they acquire 10 million subscribers.
HMNY even reaches 10 million subscribers.
Movie theaters agree to pay 100% of all income to HMNY.
Movie theaters manage to reduce operating and rent expenses as a percent of revenue by 50%.
Movie theaters are able to survive in this model even with their unaccounted interest expenses.
Film companies agree to give up 20% of their cut of ticketing revenues to HMNY.
HMNY has no other operating expenses unrelated to MoviePass subscriptions.
With these numbers shown simply, it becomes clear why Wall Street has thus far shown a complete lack of interest in buying their stock.
Further, it should be clear now why I rate this a conviction short.
Downside Risks
While I do view this as a very clear short, the main and most important thing which would be very bullish would be if subscribers started seeing fewer movies as this would decrease expenses, and if they also simultaneously started buying more concessions. I however do not see this as being so likely as the only reason to have the service would be to use it frequently, and fewer visits also would imply fewer opportunities to purchase concessions.
Conclusion
HMNY reported earnings which looked better than they really were due to non-cash flow adjustments. Because my overly optimistic assumptions are still unable to show that HMNY is cheap, it is clear that HMNY does not currently present any potential value and is a strong short candidate. Target price remains $0.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
