RealD rides a 3-d wave

Supplier of High-Tech Cinema Gear Counts on 2-D Being a Thing of the PastZ

This summer’s slate of 3-D movies has boosted the box office and drawn moviegoers back to the multiplex.

But one of the biggest beneficiaries of the craze is RealD Inc., the dominant supplier of 3-D projection and viewing technology, which in July went public with an initial stock offering that raised $230 million, with net proceeds to RealD of about $82.6 million. The IPO saw 12.5 million shares sold at $16 each, about 33% above its expected range of $13 to $15, valuing the company at about $800 million.

RealD has become the dominant technology for movie theaters looking to show 3-D films, with units installed on nearly 8,000 screens world-wide, 4,500 of which are in North America. Currently, between 75% and 85% of domestic 3-D box office comes from movies shown in Real-D.

Dolby Laboratories Inc., IMAX Corp., and MasterImage 3D LLC are RealD’s primary competitors. RealD also provides 3-D technology and equipment to the military and NASA for reconnaissance.

But if RealD is to maintain its momentum, Hollywood will have to keep churning out 3-D films and moviegoers will have to keep wanting them.

Eleven movies have come out in 3-D so far this year. But some studios are already showing signs of hesitation. Time Warner Inc.’s Warner Bros. recently quietly decided to go with a 2-D production for its coming Zack Snyder action thriller “Sucker Punch,” which was previously announced as a 3-D title.

Meanwhile, 3-D ticket sales have accounted for a smaller percentage of the debut weekends of summer hits such as “Despicable Me.” Only 45% of that film’s opening gross came from 3-D ticket sales, compared to more than 70% of the first weekend take from “Avatar.”

But many industry experts say that declining ticket sales are simply the result of not having enough 3-D screens available. There are currently about 6,000 3-D screens enabled in North America, but the number of films playing on them has doubled since last year.

“The single biggest issue facing 3-D today is that exhibitors cannot get enough projectors and silver screens….The pipe right now is backed up, and it is probably going to take 18 to 36 months for supply to catch up with demand,” said Jeffrey Katzenberg, an early promoter of 3-D and the chief executive of DreamWorks Animation SKG Inc., which now produces all its movies in 3-D. “That means sustained growth for RealD,” he added.

Despite occasional flip-flops like “Sucker Punch,” most of Hollywood continues to pin its hopes on 3-D to revitalize an industry plagued by declining DVD sales and fickle audiences.

The fresh, new experience offered by 3-D movies allows theater owners, for the first time in years, to significantly raise ticket prices. Even though movie attendance is down so far this year, box-office receipts are up more than 4%, thanks to the premium attached to 3-D ticket prices.

RealD, based in Beverly Hills, Calif., has enjoyed strong growth over the last several years, as ticket sales to 3-D movies accounted for 11% of the total domestic box office in 2009, up from just 2% in 2008. RealD’s revenue increased more than fourfold to $189 million in its fiscal 2010, which ended in March, from revenue of $45 million in fiscal 2009.

Still, the company has lost money every year since 2005, when it first deployed its technology in theaters, mostly because of its licensing model, which requires high upfront costs for development.

Each RealD installation costs the company about $10,000, but generates recurring revenue over the long-term, with the average cinema contract being about 7.5 years. The theaters pay RealD about 50 cents from each ticket sold to a 3-D movie, so it takes just five to 10 3-D movies to play on a RealD-enabled screen before RealD recoups its costs.

Analysts say that arrangement should provide a major boon to exhibitors, who derive much of their current revenue from concessions and are looking for new sources of income. “RealD put together an incredible business before the 3-D trend emerged that will yield 30 times payback for theater owners in seven years,” says Ralph Schackart, a digital-media analyst for William Blair & Company, who estimates that about 35,000 screens world-wide will be equipped with Real-D units within five years, up from 8,000 today. William Blair was the co-lead manager on RealD’s IPO.

Investors and insiders at RealD actually raised more money in the IPO than the company did, with co-founders Michael Lewis, age 47, and Joshua Greer , 41, selling 15% of their holdings for net proceeds of $17.1 million each.

Founded in 2003 when 3-D was merely a blip on Hollywood’s radar, RealD built the light-polarizing technology used in projection systems to show 3-D movies including “Avatar” and “Toy Story 3.” It now licenses that technology to 17 of the world’s 18 largest exhibitors.

“I’ve always been really interested in how technology can make the film experience better,” says Mr. Lewis, a former investment banker who founded a digital entertainment studio and produced several 3-D films in the 1990s. “The first time I saw a 3-D image on screen, I was convinced that this capability had to be brought to the masses, so that’s what we set out to do. The goal of the company is to recreate the way we see.”

In order to bring 3-D to the mass market a time when even theater owners and movie studios were tepid about the medium’s prospects, Mr. Lewis adopted a “pay as you go” model. That in turn helped RealD to grow.

“We got thrown out of a lot of offices talking about 3-D,” remembers Mr. Lewis. “The industry has such a bad history of bad 3-D over the last 50 to 100 years. But comparing that 3-D to what we have today is like comparing a Model T to a Ferrari.”

To assuage doubts and encourage theater owners to adopt its technology, RealD took on the financial burden of installing the units in theaters and offered industry giants Regal Entertainment Group, Cinemark Holdings Inc. and AMC Entertainment Holdings Inc. stock options in the company.

“We’ve told the studios we need movies that come in both 2-D and 3-D so that customers can continue to make the choice to pay more—that’s what is most important to us,” said Amy Miles, chief executive of Regal Entertainment, which received more than 1 million warrants for shares in exchange for committing to installing 1,500 screens of its roughly 6,800 screens with RealD units. So far, Regal has installed about 725 screens with RealD equipment and is working quickly to double that figure.

“We liked Real D because it was one of the only companies that focused exclusively on 3-D, and that really helped us feel comfortable,” she said. “As we move into 2011, we continue to evaluate things but I wouldn’t be surprised if we enabled 30% or 40% of our total screens to play 3-D films. We still don’t have nearly enough 3-D screens to satisfy demand, so we can’t even begin to evaluate what the demand will look like in the future.”