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Smart Diversification Makes Cineplex Inc. a Buy

Companies can do two things as new technology comes out: they can dig in and hope that the technology doesn’t take off, or they can change and adapt. Many companies, because they are led by stubborn executives, dig in and oftentimes lose. Cineplex Inc. (TSX:CGX) executives, on the other hand, realized that things were changing and adapted.

The movie theatre business is not one that I would advise any investor get in to. The advent of services like Netflix make going to the movies less necessary, especially with these companies releasing their own movies. That doesn’t mean that movie theatres will disappear; it simply means that there are more choices, and when there are more options, it becomes harder to generate revenue.

Fortunately, Cineplex has a diversification plan that I believe will help it stay relevant and help it grow over the coming years.

It’s about entertainment, not movies

Cineplex is an entertainment company, not just a movie company. Once you realize that, its strategy of diversification becomes crystal clear. And it’s already doing this with what it calls the Rec Room. This initiative is meant to keep clients in the room longer than a movie; the goal is to target each demographic.

Sports lovers can come and watch the big game on dozens of televisions while drinking beer and eating food. Mom and dad can send the kids off to play video games while they catch their breath. Rather than just see a movie, eat one bowl of popcorn, and drink one soda, the same customers might spend money on games, food, and beverages with more frequency.

On top of that, Hollywood doesn’t have to produce anything incredible to get someone in the front door. Over the next few years, Cineplex intends to launch 10-15 of these Rec Rooms.

The other initiative that I am bullish on is its recent acquisition of 80% of WorldGaming, which is a big player in the eSports business. In essence, eSports is electronic sports, where fans all around the world watch people compete in video games. This business could be huge for Cineplex. In 2014, 27 million people watched the World Championship of League of Legends.

The business model for Cineplex here is twofold. First, people are coming in to watch the video game tournaments on the big screen, which means that they could generate increased concession revenue. Second, because Cineplex is launching its own eSports league, there is ample opportunity to generate revenue from sponsors in the form of ad dollars.

Both of these initiatives, along with its movie business, are forms of entertainment that are meant to get people into the building, so they can buy food and games. And it is definitely working. Because of its cash flow, the business is able to pay a 3.12% yield, which comes out to $0.13 per quarter. To top it off, it has increased its dividend consistently over the past five years, which should have investors excited.

The reality is simple: Cineplex realized it needed to diversify and it has. And while it continues to do this, it will pay dividends that should grow as more of the Rec Room and eSports revenue kicks in.

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Fool contributor Jacob Donnelly has no position in any stocks mentioned. David Gardner owns shares of Netflix. The Motley Fool owns shares of Netflix.

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