Cineplex’s bold plan to battle streaming giants like Netflix

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The air resounds with the bleep-bloop of arcade game soundtracks, animatronic chatter and clanging Wheel of Fortune chimes. But all of this discordant racket is music to Ellis Jacob’s ears. “This is part of our whole diversification strategy,” the Cineplex CEO says, gesturing around the company’s new Playdium amusement complex.

Jacob is showing off a 41,000-square-foot glass and concrete box in suburban Brampton, northwest of Toronto, a former movie multiplex that has been gutted and revamped over the past year. Out went the 10 screens and 2,021 seats. In came well over 100 new attractions, including video games, an overhead ropes course, virtual reality booths and a prize shop full of kid-friendly ephemera such as lunchboxes, candy and smiling poop-emoji plush toys.

But the new Playdium will be more than an indoor playground to extract further disposable income from kids, teens and families. It is also a sign of the daunting challenges confronting Canada’s largest cinema chain. Cineplex’s movie attendance has been declining nationwide since 2016, and the company had a glut of screens in the Brampton area. Two of its other theatres, both a short drive away, were leeching audiences from this 20-year-old location. It was shut down for a total makeover.

Jacob and his management team have concluded that Cineplex’s best investments for the future are not solely in movies. That decision is no whim. Financial markets have sent clear signals that it’s time for a fundamental overhaul in strategy. The company’s share price plunged in 2017 and has continued to sag, declining by more than half in just over two years.

For a long time, Cineplex’s dominance of the movie exhibition sector was a strength. With 76% market share, it is by far the biggest chain in Canada. But that business is past its peak, and investors are alarmed at the astonishing rise of the new competition: Netflix Inc. and other huge online content providers that deliver movies and more right into consumers’ homes.

Jacob’s coping strategy is twofold: make more money off the people who still go to the movies (and there are a lot of them) and offer up additional forms of entertainment to give Cineplex a buffer against the ups and downs of the Hollywood production slate. The first element includes things like 3D screenings, expanded concession menus and premium tickets to VIP theatres with cushy armchairs, and food and drinks (including alcoholic beverages) delivered to customers’ seats.

The second means expanding alternative entertainment offerings. In 2008, Cineplex had no amusement and leisure segment, and revenues from its media division were limited to ads on cinema screens and in its in-house magazine. But over the past decade, the company’s non-movie revenues have grown substantially.

One of the alternative offerings is Playdium. The Brampton location is the first built since Cineplex bought the original Playdium in nearby Mississauga, and the company plans to add 10 to 15 more over the next five years.

For adults, there’s the Rec Room, a chain of seven restaurant-bars the company launched in 2016. The Rec Room features games, live entertainment and other attractions. Cineplex wants to expand the number of these as well. In recent years, the company has also pushed into e-sports, hosting tournaments for games such as Call of Duty for spectators across the country.

But now Cineplex is about to unveil an ambitious hybrid of the two strategies called Junxion. Each location will be a movie theatre where, executives hope, movies will not be the only reason to visit. The first Junxion is under construction in Mississauga and will open in late 2020, with more to follow soon across the country.

Walking in, the first thing visitors will see is not cinemas or popcorn stands but food, entertainment and gaming spaces, with the theatres tucked in behind. And like the Brampton Playdium, many Junxions will be retrofits of underperforming Cineplex locations.

“Going to a movie just to show up and watch the content—it’s not enough anymore,” says Dan McGrath, Cineplex’s chief operating officer. “If we want to get people coming out of the house, we have to create an experience.”

For years, a movie was reason enough to get people out of the house. In 2006, the year after Cineplex acquired the rival Famous Players chain, the company’s box offices welcomed 57.4 million people. By 2015, that number had increased by 34% to 77 million. As the firm kept breaking its own records, Jacob boasted about the resilience of a business built on “affordable escapism.” Investors applauded. Cineplex’s share price climbed from about $14 in 2006 to nearly $50 in early 2016.

Since then, however, movies have brought fewer people through the door. Cineplex’s attendance has declined for three years in a row. Last year, it fell to 69.3 million, about the same as in 2010. People’s entertainment habits have fragmented as technology has offered a slew of new options. That’s true for how they get their news, how they interact with friends and how they watch movies and TV shows.

Netflix reportedly spends millions per episode for its TV series The Crown, giving it a movie-like production feel. Even less splashy shows are appealing because viewers can call them up on demand for a flat monthly subscription fee. The rising popularity of gaming, especially among younger people, is yet another draw on a finite supply of leisure hours.

Jacob argues that streaming services and other at-home entertainment won’t entirely disrupt the movie theatre business, because people still want to get out of the house and have a social experience. But as online offerings proliferate—behemoths Disney and Apple have launched their own streaming services—so does competition for consumers’ entertainment time.

“When there’s a good film, people do come. What’s happening is that [the movie business] has been much more volatile than usual, because there are other alternatives,” says Jeff Fan, an analyst at Scotia Capital. “Think about how quickly you can pick up a show to see if it’s interesting and how quickly you can drop it if it’s not interesting in the first 10 minutes. You couldn’t do that 10 or 15 years ago. Now you’re doing it almost every evening.”

There’s also the problem of box office volatility because of fluctuating movie quality. Sometimes, in what are normally busy seasons, Hollywood just releases a lot of duds. In the summer of 2017, the slate included Baywatch, King Arthur: Legend of the Sword and the fifth—fifth—instalments of the Transformers and Pirates of the Caribbean franchises.

“One challenge we have with a theatre is we’re entirely dependent on the content,” says McGrath. “If it’s Avengers playing, if it’s Lion King, our theatres are filled. There are people there all the time. But if it’s a Wednesday afternoon in the middle of the summer and there’s no really big movie, all of a sudden we have all this excess capacity.”

Cineplex is not alone in this. Movie attendance in the United States has declined since the early 2000s, and investors have punished the dominant American movie theatre chain, giant AMC Entertainment Holdings Inc., even more severely than they have Cineplex. Over the past three years, AMC’s share price has fallen by almost 75%.

In Cineplex’s case, missing an important earnings target in the second quarter of 2017 prompted investors to take a closer look at those disturbing long-term industry trends. The company reported a drop in adjusted earnings before interest, taxes, depreciation and amortization (EBITDA)—a rare setback for Cineplex.

The company attributed the downturn to a decline in its ad business, as well as to increased spending on its diversification strategy. But the market was spooked. Cineplex had long traded at a substantial premium relative to EBITDA, and the earnings miss, combined with greater awareness of the competitive risk from higher-quality TV and streaming, caused some investors to reconsider that premium.

Cineplex’s share price nosedived and then kept sliding. Some analysts believe the stock has been oversold. The company’s total revenue has continued to grow, and it remains profitable. Its movie theatre business has dominant market share nationwide and is not as vulnerable to pricing pressures as chains that are concentrated in more competitive markets. Jacob also points out that Cineplex has not “overbuilt” theatres the way U.S. chains have. Its multiplexes have an average of 10 screens, while some American peers are closer to 15 or 16 per location. But Cineplex’s stock has not bounced back.

Jacob is frustrated. He believes investors haven’t given Cineplex enough credit for the steps it has taken to brace itself for the future. “Markets are fickle,” he said in an interview earlier this year. “It’s the issue of people just focusing on small pieces of information instead of looking at the big picture and saying, ‘What’s this company going to look like three to five years from now?’”

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Cineplex has made a lot of changes already. In 2008, the company’s entire business was movie theatres. Last year, by comparison, its amusement business and media division, which displays ads and content on screens in fast-food restaurants and other locations (beyond movie theatres), together accounted for almost one-quarter of its revenue.

In 2015, the company acquired the half of Playdium it didn’t already own from its joint-venture partners, and in addition to installing games in its own venues, it now supplies them to other companies. The following year saw the launch of The Rec Room. In 2017, Cineplex signed a partnership with Dallas-based Topgolf Entertainment Group and will soon open its first high-tech driving range in Canada. Last year, the chain invested in VRstudios, based in Seattle, and is installing the company’s virtual reality equipment in theatres and other locations.

Cineplex has also boosted revenues within theatres by making more money per customer. A decade ago, just 3% of the company’s box office take came from premium tickets—which, at the time, meant Imax. Today, the bells and whistles include motion-enabled seats, 3D, 4DX (in-theatre effects such as wind, rain and scents) and more. Cineplex has 165 theatres nationwide, with 1,695 screens, and more than half now have at least one high-end feature. Premium tickets accounted for 44% of box office revenues last year.

The chain has expanded its food and drink options as well. As of this past summer, adults could buy alcohol at 83 theatres in three provinces. The average customer spent about $4 on concessions in 2008; last year, that reached $6.36. Total box office revenue per patron has climbed from $8 to almost $11 over the past decade. Those wider offerings should help concession spending to keep growing, wrote RBC analyst Drew McReynolds in a research report in August.

But analysts caution that Cineplex is still highly dependent on content—the appeal of the movies it shows versus the films and series Netflix and other giants offer online. “We believe the secular challenges are going to gain in momentum over the foreseeable future, especially as some of the streaming services start to launch and pick up steam,” says Robert Fishman, an analyst covering the U.S. movie business at MoffettNathanson in New York. “That’s going to add another pressure to the industry.”

In short, Cineplex has to keep diversifying and raising its game. And that is exactly what it’s trying to do with Junxion.

None of the three basic elements of Junxion—movies, food and drinks, and arcade games and other attractions—is new for Cineplex. The company has tried building gaming sections into cinemas before, including its 34 Xscape locations, which blend movie theatres with entertainment areas. But because of the tiny kitchens in those sites, the restaurants tend to have limited menu options. That means people who really want to play games could be drawn in, but the company has missed out on attracting customers who might prefer to just grab a drink and a bite.

Junxion is designed to address that problem. Roughly one-third of the space will be movie theatres. Another third will be gaming and other entertainment, such as a stage for live events. The final third will be a food hall concept with several stands serving different fare and beverages. It will also have an indoor food truck, where the items will change often, and which could allow for pop-up partnerships with local restaurants.

Construction on the first Junxion is starting soon at the Erin Mills Town Centre in Mississauga, and it will open in late 2020. A second, slightly smaller version will debut shortly after that at Kildonan Place in Winnipeg. Unlike a Rec Room or Playdium, Junxion will have clear Cineplex branding on the building to emphasize that there are still movies inside.

But movies will not be front and centre. In an artist’s rendering that Cineplex COO McGrath shows off, the auditoriums are tucked away, down what the company calls “theatre street.” They will all borrow the VIP concept of in-seat service, with only a small concession stand just outside.

Instead, the Junxion lobby will be dominated by the food hall, a café, a bar and a stage for programming that could include a magician for young families, cooking seminars or live music, depending on the time of day. The amusement area will include video games, traditional lounge options such as foosball and pool, and virtual reality pods.

Many of the locations, such as the one at Erin Mills, will also have rooftop patios, with games like bocce, a lounge and outdoor retro-movie screenings in the warmer months. These could also serve as spaces for presentations or private events, McGrath says.

Strategies such as Junxion could give Cineplex more sway with shopping mall owners. Many are struggling with declining customer traffic, and want to reinvent their spaces to include more destinations and experiences. They are approaching Cineplex more often, McGrath says, and in many cases the company is pitching those mall owners on theatres with other entertainment offerings built in.

Cineplex is not interested in opening any new locations that do not at least have VIP as part of the plan. Many of these will also have Junxion concepts or Playdium add-ons.

The same strategy applies to retrofits of existing theatres. At one in Oakville, Ontario, five screens are currently being converted to VIP, and two are being removed altogether to make room for an expanded kitchen and a lounge.

Depending on the individual market and the space available, Cineplex will evaluate whether a retrofit will mean a Playdium put in where five or six screens used to be; more VIP, Xscapes or VR facilities added; or a full Junxion concept. The company expects to retrofit 20% to 25% of its theatres in those ways in the coming years. The first Junxion in Mississauga is a new build, but it will be a template for other sites, including renovated ones.

Building a new location—whether a movie theatre or another concept—costs about $10 million, McGrath says. Retrofitting an existing location is closer to $5 million, depending on the scope of the renovation. It takes four to five years to make the investment back, he adds.

Each concept has a different target: Playdiums do well with families, younger kids and teens. VIP theatres draw in adult audiences. Rec Rooms attract millennials and Generation Z. Junxion is designed for broader appeal—not only families with kids but also teens and people in their 20s and 30s.

“Right now, there’s no reason to come to our theatres unless you’re coming to a movie,” McGrath concedes. “We want to give people a reason to come in those off-peak periods when there’s not necessarily content you want to see.”

Going to a movie theatre just to hang out may not sound all that appealing. Much will depend on how different the look and feel of a Junxion is from a theatre and how good the food is. But McGrath also points out that many Junxions will be in suburban neighbourhoods, where the options to go out and socialize are not as bountiful as they are in city centres. Another part of Junxion’s strategy is to make money from having longer opening hours, when a typical movie theatre might not offer enough to keep customers there or draw in more.

Back at the new Playdium location in Brampton, Jacob shows off a large cabinet housing an arcade version of the popular Halo video game, complete with a 360-degree swivelling gun and wide screens. Young gamers can compete with friends live, in person, rather than holing up in their parents’ houses, talking to one another on headsets, he says, pointing proudly to the sharp on-screen graphics.

“It’s hard to replicate this at home,” he says. Cineplex is betting on it.

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