CGX - Cineplex

[valueinvestor]

I just want to present an interesting idea that I have pondered for a while, hopefully you all can provide some insights, but for now - here's another of my ramblings.

 

A stock that was worth $34 on a take over basis, $22 prior to COVID-19 is on the market for $10.65 today.

 

It's one of those stocks that haven't been restored to their former glory, even though there are other industries with fewer legs to stand on that are almost back to normal on a price per share basis.

 

Do I think this situation will make them weaker in the long-run? No. Short term will be holding CGX hurt? Probably.

 

Unless we have an apocalyptic situation where people do not go to theatres anymore, markets are valuing this at $12-15M per theatre or $4M net of debt/lease obligations.

 

It's the best theatre play I know, as they have a virtual "monopoly" or rather no real competitor with an almost hidden asset, which is their SCENE points program that has 10 million members (to provide perspective, there's almost 40 million Canadians).

 

Bear Case:

Theatre attendance experienced a year-over-year decline, this is true, but again markets valuing Cineplex at $12-13M per theatre. These are best-in-class theatres in prime locations with a growing Food and Amusement business within them.

 

Streaming will kill them. I think there's going to be a situation where if you can't beat them, join them. Just like how Amazon is built physical stores, streaming companies may want to have theatres under their fold to enhance the customer experience. Does this automatically translate to downside protection - No - maybe they'll wait like Amazon, where they are only kicking the tires of AMC when it's close to bankruptcy.

 

Do I think it's a bargain at $10.65? No, because Cineplex increased their prices 10 fold over the last decade, and I think there will a reversion with attendance decline because of COVID-19. Do I think they're at risk of bankruptcy? No. Especially with the Canadian Government support, it's hard to see it happen. In the very least, their partnership with Scotiabank may help them.

 

The only thing that makes this a bargain is that they're the best house in the worst neighborhood. Hell, the market is pricing it less than the GFC.

 

So if we discount possible hope for a transformational partnership with a streaming partner, the inclusion of virtual/D-Box initiatives, closure of Mom and Pop Theatres, interactive, growing amusement/food business, what are these theatres worth on the public market? I think $12-$15M is fair for best-in-class theatres with prime locations.

 

What do I think the market is missing?

How much will a person pay for a loyalty program that has a quarter of the Canadian population on it that has useful data and integrated into an app? At $200 per member, you get the entire enterprise value. Generous? I don't know, just taken a look at the stock because simply it's the next annual report I'm reading.

[bizaro86]

Seems like the sort of thing Fairfax would like. Short term economic distress is a cyclical and/or declining industry seems like their bread and butter. Plus the Recipe restaurants are already Scene partners.

 

In all seriousness, I think this might be a good recovery play. One thing that concerns me is a chicken-and-egg problem with new releases. Until lots of theatres are open and people come back studios wont want to release their big films. But without big films to draw people back, the recovery in attendance could stall.

 

I think their arcade business is an interesting one, and their stand-alone versions have started opening up already. I like this a lot better than US comparables because their market share is very high, although Landmark has actually been building new theatres from the ground up lately, which isnt great news.

[Guest roark33]

The slate for the rest of 2020 is really weak:

 

Tenet

Mulan

Black Widow

No Time to Die

Top Gun

 

But, lots of movies have been moved back to 2021.  Movie theaters will probably burn cash until at least november. 

 

I found this article useful regarding the theater slate (amc is the focus here)

 

https://seekingalpha.com/article/4354750-avoid-amc-entertainment-weak-movie-slate-will-strain-balance-sheet

[valueinvestor]

True.

 

It’s really ugly. No doubt about that.

 

I also think this a question whether the business survives or the assets? I am willing to bet theatres are not going to go extinct in the next ten years, but will cineplex the business exist in ten years.

 

Cineplex has enough liquidity imho, but is it worth holding long term relative to another opportunity.

[Foreign Tuffett]

A few things:

 

Makes much more sense to value cinema operators on a per screen basis, not a per theatre basis. Ignoring lease liabilities and their other assets, market is valuing each of their screens at about 563 or $563K USD. In a "normal" environment that would be cheap given the (apparent) quality of their locations, but obviously we are far, far from a normal environment. It is unclear to me what the future of the industry looks like, although I certainly don't think the entire industry will disappear. 

 

What's the latest on their debt? At YE 2019 they were 2.32X levered. Obviously they are going to breach the 3.75x covenant. You wrote "Cineplex has enough liquidity imho", but what makes you think that?

 

I wouldn't pay any attention to where the market was pricing this during the 08-09 financial crisis/Great Recession. Frankly, the industry is in worse shape than it was then. Also, cinemas have traditionally been quite recession resilient.

 

 

[valueinvestor]

A few things:

 

Makes much more sense to value cinema operators on a per screen basis, not a per theatre basis. Ignoring lease liabilities and their other assets, market is valuing each of their screens at about 563 or $563K USD. In a "normal" environment that would be cheap given the (apparent) quality of their locations, but obviously we are far, far from a normal environment. It is unclear to me what the future of the industry looks like, although I certainly don't think the entire industry will disappear. 

 

What's the latest on their debt? At YE 2019 they were 2.32X levered. Obviously they are going to breach the 3.75x covenant. You wrote "Cineplex has enough liquidity imho", but what makes you think that?

 

I wouldn't pay any attention to where the market was pricing this during the 08-09 financial crisis/Great Recession. Frankly, the industry is in worse shape than it was then. Also, cinemas have traditionally been quite recession resilient.

 

 

 

True. It makes more sense, I didn’t really want to delve deeper on precise asset valuation. We’re not Brookfield, where we can take advantage of a less than replacement cost investment without a vulture or two coming in to steal our meat.

 

As for liquidity, you’re right. But seeing the trend that’s going with Canadian companies, most are willing to lend and extend. So breaches are not treated the same, as they were last time.

 

I’m more interested in the cash-flow generated by the business and how to discount that and arrive to a value.

 

Asset-wise it’s good. Business-wise, I’m not sure.

 

I think when the dust settles, Cineplex will be standing. But as a common shareholder, are we going to profit from that.

[samwise]

Besides the current lockdown concerns, I have doubts about management.

 

At one point weren’t they di-worsifying into restaurants and also had hopes of selling tickets with some future online movie download. Has capital allocation improved?

 

Scotiabank has the scenes card. Do you know it’s market share? How does it compare to the Aeroplan cards biz of CIBC and TD, which were proven very valuable in the fracas between AC and AIM?

 

Disclaimer: I owned long ago, and management never seemed happy to run the cash cow business. They were always stretching for growth in a stagnant business. But it’s distant memory now, so happy to hear anything new. The underlying business was quite good, since it’s basically a monopoly. As long as there is a theatre window.

[valueinvestor]

I think it’s more valuable? No?

 

One can’t really possibly know, as Scotiabank or Cineplex doesn’t break the scene card economics, but Scotiabank can’t have this profitable relationship with anyone other than Cineplex, as they don’t have any other option. Don’t know the market share, but it should be considerable. There were only 5M Aeroplan members, as mentioned Scene has 10M.

 

Management has been “Eddie Lamperting” the company for a while, but again they need to innovate. In terms of capital allocation, it maybe bad, but if they don’t figure out a solution to get with the times, they’ll be dead like blockbuster. I never really disagreed with Lambert, but the business was tough. At least with Cineplex, even with this dire economic situation, they are not in a bad position as AMC.

 

At this moment, I don’t think this is something where common investor can profit. Most likely will be an activist play such as Rosenstein with Whole Foods or strategic acquisition.

 

However as a Canadian, if someone told me I could own 10% of Cineplex for $67M CAD, I would be surprised.

 

 

[Guest roark33]

One interesting take on this movie industry currently is asynchronous global movie release.  WB has been heavily advertising Tenet as August 12/13 release date, but that seems highly unrealistic given CA and NYC current regulations.  WB could just go ahead and release Tenet and let the chips fall where they may over the course of a couple of months.  In this case, CGX would be in a great situation since almost all of their theaters could be open, whereas AMC with heavy large city US operations wouldn't do so well. 

 

 

[valueinvestor]

Yep! It's interesting for sure.

 

Especially with the release of Cineplex Unsecured Convertible Debentures @ 5.75% with Conversion Price at 10.94 IIRC.

 

Again the loyalty program is valuable - they own 50% and it's doing around 100M in revenues. Although it's losing money, I'm sure that will change when Recipe Unlimited and other partnerships start flowing through.

 

It's cheap, but I'm still wondering if this is the case where I get all the answers right and still get a C+. I was not a fan of the Cineworld/Cineplex deal.

 

[Guest roark33]

I used to be pretty negative on AMC because movies just kept getting pushed back and I wasn't sure if they would survive that long.  However, the flip side is, once this opens up, there are going to be a ton of great releases, just packed, each week.  Studios could even move movies up once things open back up. 

[valueinvestor]

What do you think about the esport opportunity with these businesses? I think that was Wanda’s angle when acquiring a chunk of AMC, IIRC?

[Foreign Tuffett]

At least one analyst thinks no new Disney film at box office before the end of September:

 

https://www.hollywoodreporter.com/news/disney-analyst-downgrade-longer-pandemic-impact-cinemas-closed-1303411

[valueinvestor]

I appreciate the link Foreign Tuffett!

 

Any chance you looked at the debentures? They recently closed one for $275M

[valueinvestor]

Someone reached out said do the math, because my posts lack them.

 

Typically I don’t because, I find qualitative aspects are much more informative then the financials. However, here’s a simplistic one.

 

Zero out cash flows this year, keep the same level of maintenance capex, and half the cash flows for the subsequent years, and you’ll arrive at a valuation at least 20% higher than the share price or 50% less than TEV  with a discount rate of 10%. Personally I think it’s conservative, because with the Cineworld transaction, they applied an EBITDA multiple, and EBITDA paints a very different picture. Also $275M of the debt is convertible, which can paint another picture too.

 

In fact, here’s a link to Cineworld’s investor’s presentation on the matter when they were in the process of acquiring Cineplex. https://www.cineworldplc.com/sites/cineworld-plc/files/reports-presentation/2019/investor-presentation-acquisition-of-cineplex-16-12-2019.pdf

 

I think this is idea interesting, not sure it’s an investment. Sometimes your upside is capped because it’s easier to squeeze out minority shareholders in Canada, as opposed to the US. You can definitely buy more shares before disclosing.

[samwise]

This investor letter mentions CGX and thinks that the repeal of the Paramount decree (USA) will enable a studio to buy CGX (Canada).

 

https://seekingalpha.com/article/4370018-mittleman-brothers-q2-2020-investor-letter

 

1. Does that make sense? US decrees don’t apply in Canada, and I thought some studios did own theatres outside the US.

 

2. Why would studios be interested today in buying theatres?

 

https://en.m.wikipedia.org/wiki/United_States_v._Paramount_Pictures,_Inc.

[valueinvestor]

I realized this when looking through the web, I suspect mittleman saw the same source. My understanding was the US Decree applies to US companies - hence US studios could not own Canadian theatres as it violates the decree, but Canadian Studios can own Canadian theatres. Now with the repeal, there's a chance that it could allow US studios to own theatres, but again history wasn't really kind to studios (at least in the US) who owned theatres, if I remember correctly.

 

I haven't really looked at it, as mentioned the value is definitely there, but not sure if common investor can extract it.

[samwise]

Thanks. Which source are you talking about, that Mittleman may have seen. Any links?

[valueinvestor]

Tried finding it so I could link it but there was a page when searching the Cineworld/Cineplex deal and it mentioned why US studios could not own Canadian Theatre until recently.

 

Wish I had it but hopefully this helps, after the run up I sold and invested in other longer term investments. So not really looking at the name anymore.

[Foreign Tuffett]

Tried finding it so I could link it but there was a page when searching the Cineworld/Cineplex deal and it mentioned why US studios could not own Canadian Theatre until recently.

 

Wish I had it but hopefully this helps, after the run up I sold and invested in other longer term investments. So not really looking at the name anymore.

 

I think Tenet, even if successful, is likely to be a bit of a poisoned chalice for the cinema operators. We won't know for sure for some months

 

https://screenrant.com/tenet-movie-box-office-warner-bros-theater-split/

 

Besides The New Mutants and Tenet, there also don't look to be much of anything else on the release schedule before October. Can a C level superhero movie and Nolan blockbuster carry the industry for an entire month?

[wabuffo]

For those interested, here's the Mittleman's posting their Cineplex investment as a ValueInvestorsClub (VIC) idea (for those with 45-day guest access - you just have to sign up for free access. Default is 90-day guest access).

 

https://valueinvestorsclub.com/idea/CINEPLEX_INC/2558512132#description

 

wabuffo

[Foreign Tuffett]

For those interested, here's the Mittleman's posting their Cineplex investment as a ValueInvestorsClub (VIC) idea (for those with 45-day guest access - you just have to sign up for free access. Default is 90-day guest access).

 

https://valueinvestorsclub.com/idea/CINEPLEX_INC/2558512132#description

 

wabuffo

 

Thanks for posting that.

 

In some ways (like the history section) that write up is very well done, but other parts are a little puzzling.

 

So apparently "The Canadian movie theater box office has been essentially flat over the past 10 years", but Cineplex has grown share ("managed to grow sales from C$964M to C$1,665M (+73%, 5.6% CAGR) over those same 10 years.").

 

The author's conclusion is "the out-performance Cineplex achieved over the previous decade bodes well for its prospects." My thought was the opposite, they already have 69% market share. How much more share can they take? At a certain point they aren't going to be able to outpace the Canadian box office.

 

----------------------------------

 

These guys were also quite wrong about Carmike's value. They made a big fuss about AMC getting a bargain, but, as we learned on AMC's Q2 2017 call, the real story of the Carmike acquisition was AMC overpaying for relatively low quality cinemas.

 

They were also wrong in seeing AMC as a good opportunity after the Carmike acquisition closed....not to beat a dead horse (so to speak) but even disregarding COVID these guys have been generally wrong about the industry for years now

[5xEBITDA]

I commented on this in the Aimia thread but probably more appropriate here so as to not derail the Aimia commentary.

 

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Meh. Not super impressed with the thesis...I know he has a long history with the theater industry, but I think the bigger picture is missed here. It doesn't make sense to say that just because theaters re-open people will go back. There was a great article regarding this on Bloomberg yesterday - I recall about 60% of survey respondents (who described themselves as frequent movie goers) won't go back to the theaters just because they re-open. The second problem is his reach that the Company will be able to thrive during a flat box office as they've done in the past without going into detail on how they did that. You thrive in a flat market by having pricing power, which being a #1 in the market gives you. Increasing ticket & food prices is a great way to offset declining ticket volumes while also boosting your margins. I think it's safe to assume that once theaters re-open they will need to cut pricing in order to just get people in the door. It makes zero sense for him to be modeling a go-forward margin higher than the 2009 - 2019 average.

 

The other thing I'll add here is that at this point, the movie theater industry is incredibly well researched by deep value / distressed investors and where the industry's stocks & bonds are priced is probably somewhat of an efficient price.

[valueinvestor]

To be fair, I think Cineplex is a different breed when comparing AMC and other companies - I never found the theatre space compelling, but at the end of the day Cineplex is valuable (there's no doubt).

 

I also have mixed feelings about Mittleman, as I always seem to not agree with their thesis but SOP seem to be on point. I think they always think that if they have 100%+ upside, then anywhere in the middle should be fine. Also Aimia left a bad impression, especially when they settle for less than SOP value without so much of an explaination.

 

Which brings me to my issue with Cineplex, what happened at Aimia could happen here. The issue is not value, but rather extraction for common shareholders. If I was an large investor, I would definitely focus on SCENE - there's a lot of potential. Imagine what SCENE would valued with a spin-off transaction, and ran as an independent public company.

[jasonchin]

Can Scene exist without Cineplex? It's similar to the concept of network effect. If the customers aren't attracted to the platform, the value of the platform should decrease.