Hollywood's Ship Is Sinking: Is It Time to Short Movie Stocks?

Earlier in December, I wrote an article entitled "Hollywood's Still Not Getting It (Bring On The Sky Pirates)" regarding problems in the motion picture industry and troubles that Hollywood is having getting people back to the theaters. In that article, I argued that problems with box-office revenues may have something to do with the quality & appeal of films in theaters and ongoing economic problems in the US. I previously wrote, "With rising food and fuel prices, Americans understandably have less money for discretionary spending on things like movies and going to restaurants." In this way, Americans do not have funds to spend on roll-of-the-dice entertainment; when it comes to movies, it appears that Americans want guaranteed bang for their buck.

For a trader with a bearish outlook on Hollywood and the entertainment industry, I previously mentioned Regal Entertainment Group RGC and Cinemark Holdings, Inc. CNK as being possible short positions. Traders who saw this opportunity to short the movie industry were not disappointed. Since the writing of that article, Regal Entertainment has fallen to $11.96 per share from $13.72. Likewise, Cinemark has fallen to $18.41 per share from $20.08.

In that same span of time, DreamWorks Animation SKG, Inc. DWA has fallen to $16.57 per share from $17.60. IMAX Corporation IMAX has fallen to $18.95 per share from $20.73. Further, Lions Gate Entertainment Corp. LGF has fallen to $8.00 per share from $8.48.

According to an Associated Press article posted Wednesday written by David Germain, it appears that Hollywood's problems are far from over. According to Germain, "movie crowds keep shrinking -- down to a 16-year low as 2011's film lineup fell well short of studios' record expectations". In a time of year when studios expect many to go to the movie theaters to enjoy the holidays or avoid the cold outdoors, the movie industry continues to have trouble getting people to shell out money at the box-office.

Even in taking into account higher ticket prices, Germain wrote that "movie attendance is off even more [than projected domestic revenues for the year], with an estimated 1.28 billion tickets sold, a 4.4 percent decline and the smallest movie audience since 1995, when admissions totaled 1.26 billion". 1995. Germain wrote that "[j]ust what has put the movie business in the dumps is anyone's guess" -- though some of us have our own theories on problems with Hollywood. Issues with Hollywood movies are by no means breaking news or unforeseen. Nevertheless, Germain noted that "the tight economy, rising ticket prices, backlash against parades of sequels or remakes, and an almost limitless inventory of portable and at-home gadgetry to occupy people's time" are likely contributing to the film industry's woes.

While some high-profile films ended up being lackluster, "[b]ig franchises still are knocking it out of the park." Conjecturing on causes of Hollywood's sinking, Germain suggested that fans may be "growing tired of over-familiar characters and stories". Germain also suggested that it could be owing to movies' cannibalizing other movies' audiences or owing to the economy. Germain then wrote that, "it could be [because of] the times we live in, when audiences have so many gadgets to play with that they don't need to go to the movies as much as they once did". (Oh boy, it sounds like the movie industry may start playing the old anti-technology card.) Germain's comment regarding gadgets may be correct, but it seems to reflect a sense of desperation. There was Obama's comment on ATMs and now, it sounds like the PlayStation 3, cell phones, Keepon robots, and the Amazon Kindle are keeping Americans from going to the movies.

Though the past year was rough for Hollywood, the lineup going into 2012 looks fairly promising with "The Dark Knight Rises", "The Amazing Spider-Man", "Men in Black 3", a new James Bond film entitled "Skyfall", and Peter Jackson's "The Hobbit: An Expected Journey" based on JRR Tolkien's "Lord of the Rings" universe. In addition, 3-D reissues of "Titanic", "Finding Nemo", "Beauty and the Beast", and "Star Wars: Episode I - The Phantom Menace" will be released. Thus, according to Germain, "there's good reason for optimism in Hollywood".

It sounds like Hollywood is in the process of releasing new movies and even re-releasing old movies that may appeal to American audiences. That could be a signal to traders to go long on movie stocks in 2012. However, the quality of movies in the theaters makes up only one side of the issue. As I have previously written, if Americans continue to face high energy costs and rising food prices, then there will most likely be no funds left for fun, entertainment, luxury, and leisure. Hollywood could make the best movies in the world, but if no one has money to go see them, then the American film industry will continue to struggle.

I am sure that there are other issues that play into Hollywood's predicament including marketing issues, pirated materials, linguistic issues, and the difficult task of trying to produce films that will be appealing to a culturally-diverse, incohesive American audience with a wide range of tastes & interests, but at the end of the day, if people do not go to the movie theater and are not willing to pay money to see movies in theaters, then the film industry will continue to falter.

That being the case, as Hollywood finds itself swimming back up to the surface by way of the American audience, we cannot lose sight of the fact that a heavy economic weight remains tied to the American audience's leg. At the end of the day, between movies and food, I think that most Americans would choose food. Even with stellar, blockbuster films out in the theaters, a dismal economy with little growth could ultimately make for more problems and less revenue for the American movie industry.

• Go long on Dreamworks SKG DWA, Imax IMAX, the Walt Disney Company DIS, and Lions Gate Entertainment LGF.

• Check out going long on Netflix NFLX. Traders could also short Regal Entertainment Group RGC, Cinemark Holdings, Inc. CNK, and the other stocks mentioned in this story.