As subscription service MoviePass writhes in the business equivalent of cinematic death throes, let’s take a moment to anticipate a post-mortem analysis, should its 92% owner, Helios and Matheson Analytics (NASDAQ: HMNY), shutter the deeply unprofitable service to stave off its own ruin. MoviePass has run up spectacular losses in 2018, and in this article, we’ll examine four lessons investors can learn from the most visible movie industry failure in recent memory.
1. Investing in a speculative, two-stage plan is folly
MoviePass recently curtailed its unlimited subscription model, which allowed moviegoers to attend one screening every day for only $9.95 per month. The new plan allows subscribers to see up to three movies each month, from a selection of six titles daily. Additional tickets may be purchased during each 30-day period at a $5 discount.
The company’s initial unlimited model was a disastrous proposition, but this latest iteration is also harmful from a financial perspective. MoviePass reimburses movie theaters for every ticket sold, so after a subscriber’s first film outing in a given month, the service is on the hook for subsequent movies that subscriber watches.
But consider the case of a customer who watches just one film within a month: MoviePass is already in the red on the subscription for that period, as it has no revenue to apply to its own overhead expenses.
So if the core MoviePass service is designed to incur losses, how could the company post any profit? Management essentially views its business model as a two-stage plan: First build a massive customer base, then, enabled by the size of the base, create lots of services that will absorb the negative margin. The parent company said as much in its 2017 annual filing with the SEC.
MoviePass’ business model was based on an assumption that a powerful subscription base would lead to paid deals with movie studios and independent distributors, who were eager to drive traffic to their films through its platform. The company also anticipated benefiting from digital advertising revenue, as well as selling the data it collected on its subscribers’ purchasing habits to film studios. None of these or other planned revenue streams has materialized to a meaningful degree.
For the most part, investors would be wise to avoid start-up business models that are constructed to lose money at the outset only to switch to a plan B that will rain profit at an undefined future date. It’s tricky enough to invest in a low-margin business that can quantify future profits once it reaches a certain scale.
But to run a business that, at its core, may never achieve profitability and to expect to layer on a slew of profitable services later — well, that’s a recipe for disaster. More specifically, it’s a recipe for the 99.9% share-price decline that Helios and Matheson stock has experienced this year.
2. Common sense and five minutes of research can save your investment dollars
Could Helios and Matheson still pull this out? It’s possible, but extremely unlikely. If the plight of MoviePass tells us anything about investing, it’s that simply consulting an organization’s financial statements can wipe away the confusion of a narrative that seems at odds with reality.
Take Helios and Matheson’s latest quarterly report, and its analysis of performance by segment. Here we see the effect of rapid growth coupled with unsustainable economics. MoviePass grew massively over the last nine months, going from 1 million to 3 million subscribers as of June 30, 2018.
In the first six months of 2018, Helios and Matheson’s subscription, marketing, and promotional services segment recorded revenue of $122 million while its costs of revenue for the same period came in at $313 million. In other words, the MoviePass business incurred a gross loss of $191 million before accounting for even a dollar of overhead expenses.
As a result, Helios and Matheson burned through $219 million in cash in those six months. Through successive rounds of equity and debt offerings, the company was able to supply $209 million of this cash loss. Common sense, however, tells us that lenders and potential purchases of equity are unlikely to fund a broken business model for much longer.
3. Always make sure cash-burning companies have reliable cash flow before buying shares
Perhaps reviewing the most recent income statement to illuminate MoviePass’ pitfalls, as we have above, relies too much on hindsight. Were there any warning signs an investor could have heeded to avoid Helios and Matheson before the collapse became evident? There most certainly were. Even before the MoviePass acquisition closed in December 2017, potential shareholders had a chance to read over Helios and Matheson’s first nine months of results in 2017.
Those who leafed through the filing would have observed that the company generated a pre-MoviePass loss of $55 million dollars through the first three quarters of the year. Additionally, after years of losses, the organization showed scant resources on its balance sheet to support any losses by MoviePass, let alone the magnitude of red ink that has been spilled thus far in 2018.
It was apparent from 2017 financials that the only mechanism for Helios and Matheson to fund MoviePass’ negative operations would be to issue more debt and equity. That’s sadly become a pattern for this company, leading to shareholder dilution, a weaker balance sheet, and a share price that is hovering around $0.02 at the time of this writing.
4. Beware self-proclaimed disruptors
What upstart company wouldn’t want the power to disrupt an industry while accumulating outsized profits? In Helios and Matheson’s press release on the acquisition, both early investor Chris Kelley and MoviePass CEO Mitch Lowe spoke of how MoviePass was “destined” to disrupt the movie industry.
If we pause for a moment and consider the idea of destiny, it’s evident that only a handful of companies can truly upend the economics of a given industry at any point in time. Yet it seems that every second or third start-up that gains traction in the investment community vows to radically transform the business environment in which it will compete.
Even in the best investment cases, “disruption” is a simply a hyperbolic buzzword meant to dress up a set of key advantages. It’s crucial for investors to realize that it’s a much more sound move to buy companies that can exploit inefficiencies in a market, or create value through technology or a competitive edge, than it is to risk money on organizations that seek to topple long-held practices — especially in an entrenched, static industry like the movie business.
After all, industry stalwarts rarely welcome wide-scale disruption — it hurts their profits. In MoviePass’ case, most theater chains never really warmed to the idea that theater patrons would pay less for their product. They harbored well-founded fears that a cut-rate subscription service might turn the movie business into a commodity, and dull the magic of a night at the big screen, eventually curbing traffic. AMC Entertainment‘s movie theater arm in particular was openly antagonistic. Funny enough, though, AMC recently launched a competing premium service, called AMC Stubs A-List, with a price point of $19.95. It has added roughly 260,000 subscribers in just a matter of weeks.
A parting thought on subscription businesses
Part of MoviePass’ initial allure to potential investors was its promise of easy money in the form of recurring, subscription-based dollars. The success of subscription-model businesses, including Unilever‘s Dollar Shave Club and fashion purveyor Stitch Fix, has certainly captured investors’ imaginations. Yet it’s crucial to recognize that a subscription-based model doesn’t bestow any inherent advantages on a company. The structure works when subscribers stick around, and when the corporation’s basic economic equation is set up for profitability. Without these key elements, the only thing that will be disrupted is an investor’s portfolio.
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