Description

THESIS OVERVIEW

This is a write-up for long AMC Entertainment (AMC), and it’s also for long National Cinemedia (NCMI), of which AMC is a 25% owner.  I know another member recently wrote up AMC, but I had this in process and think the story deserves a little more meat on the bones..

I was short NCMI for most of the past 18 months, recently covered, and now I’m long.  What has changed?: (i) a guidance miss at 4Q earnings, (ii) a guide-down at 1Q earnings, and (iii) the stock is down ~50% YTD.  However, I’ve come to view the dividend as less at-risk than I had previously thought, due primarily a lower cash tax rate.  While the overhang of AMC’s share sale remains, at a 12% dividend yield, I believe this overhang is over-discounted; and I believe the stock will trade back to a SD% divi yield after the overhang is (at least temporarily) alleviated, whether through a secondary or M&A involving AMC’s stake or the entire NCMI enterprise.  Lastly, the stock is just much cheaper now - it has never traded wide of a 7% divi yield, and now it trades at ~12%.  This only makes sense in the context of a divi cut, which I see as unlikely.

The upside in NCMI offers upside optionality to AMC, given its 25% ownership of NCMI and the need to monetize that stake near-term.  But even ignoring the opportunity in NCMI, I believe AMC’s -25% YTD performance reflects a technical dislocation in the market, and presents a compelling buying opportunity.  YTD box office is +MSD% and QTD is +LSD%, and AMC beat Street in 1Q.  However, by looking at the stock chart, you would think fundamentals are falling off a cliff.  They’re not, and I believe the May selloff in AMC to be primarily technical in nature.  First, there's a bit of sell-the-news dynamic after a string of deals that had the stock strong bid all of last year.  Second, there was over-blown concerns around 1/2 of Terra Firma's shares coming off lock-up on May 31.  Third, AMC recently sold stock in a secondary, likely leaving some uncommitted holders with shares to sell.  Fourth, a number of PVOD headlines have hit, and whether suggesting yes-PVOD or no-PVOD, the stock always reacts negatively to these headlines (the mere subject is toxic for stock performance).  Fifth, see AMC's YTD stock performance (-30%) versus peers CNK/RGC (flat) below.  Lastly, all of this, in a levered stock, with a heavy HF/platform holder base = messy trading.

Ultimately, I believe exhibitor stocks have emerged as a rare pocket of value in the current market, and I see 50-60% upside for NCMI (from its 12% yield and multiple expansion back to a SD% divi yield) and >70% upside in AMC (from EBITDA growth and multiple expansion) over the next 6-12 months.  AMC mgmt sees upside too and has bought ~$350k worth of stock in the past week.  RGC (short) offers itself as a decent box office hedge, given its relative outperformance and the Anschutz overhang.

NCMI: UPDATE

I’ll start with NCMI, which I believe is attractive on a standalone basis, and also offers added upside optionality to AMC.  I have formerly written up NCMI in two prior postings (one long and one short), and both had active message boards.  So, I will just provide a quick update here, and explain why I am now long.

NCMI guided below Street for FY’17 on its 4Q’16 call, and then had to take down that guide on the 1Q call, due to a soft scatter market.  I believe the bar has been sufficiently lowered, and NCMI’s guidance for the year is now attainable.  At the mid-point of guidance, mgmt has indicated it is covering its dividend.  I was at-first skeptical of this, but have come to understand that the prior mgmt teams 35% cash tax rate guidance has been proving conservative, and the current mgmt team sees a mid-20s% tax rate for the foreseeable future (note: because of a tax-sharing arrangement with the founding members, it is difficult to discern the actual cash taxes paid by NCMI, the Holdco).  Per the below, reflecting this cash tax rate, NCMI is covering its ~12% dividend.  In addition, NCMI has $75mm of cash sitting at the holdco, with a sole purpose of providing a cushion for the dividend.  Even if the operating company generated no cash flow (a very unrealistic assumption), cash at holdco is sufficient to cover more than one year of dividend payments.  Bottom line: even if the dividend coverage fell below 100%, the board is NOT likely to cut the dividend.    

Lastly, I would note that at this stock price, NCMI trades at <9x EBITDA, and a ~12% FCF and dividend yield.  It is a stable business with ~50% EBITDA margins and essentially no capex needs.  The fixed cost of the Theater Access Fee stepped up in 2017, impacting margins, but doesn’t step up again for five years.  There is a realistic chance that NCMI could be purchased by private equity, especially given press reports that PE is kicking the tires on NCMI’s smaller competitor, Screenvision. 

AMC: BUSINESS OVERVIEW

AMC is one of the ‘Big 3’ US exhibitors that dominate ~2/3 of the US box office.  Of the three, AMC has the best quality assets and has been a first-mover in successful growth initiatives such as theater “reseats” it embarked upon in 2013 – RGC/CNK are now playing catch-up as copy-cats.  In Jan 2016, Adam Aron took over as CEO and has demonstrated a large appetite for M&A.  He immediately pursued a deal to acquire Carmike (CKEC), the fourth largest US exhibitor, and then branched out into European markets.  Recent deals are as follows:

Now, AMC is the largest exhibitor in the world with over 1k theaters and 11k screens.  Its legacy theaters skew toward larger markets, while the CKEC network (10-15% of revenue) is in smaller and rural markets.

AMC has been investing a significant amount of capex into a major renovation cycle that will largely end next year.  Investment is being made in multiple initiatives, the largest of which is theater “reseats”, which involves replacing old seats with wider, more comfortable, reclining seats.  These reseats result in a meaningful attendance and cash flow uplift, and returns on investment of >25%.  Approximately 40% of the legacy AMC circuit has been renovated to date, resulting in attendance +47%, price +7%, and total revenue +64%.  Mgmt is targeting renovations on 25-30% of its circuit in each of 2017 and 2018.  In addition to reseats, AMC is pursuing dining initiatives, enhanced viewing (IMAX, Dolby, etc), and digital marketing initiatives.

AMC: INDUSTRY OVERVIEW

Theatrical exhibitor is a consolidated and stable industry.  Attendance has been trending slightly lower, but has essentially been stable in a range of 1.25-1.4mm for the past ~12 years.  Strong pricing power, fueled by premium experiences (e.g., Imax, dining, reclining seats) has driven box office growth.

Historically, theatrical attendance has been resilient even in a recession (e.g., 2008-10 were strong years for attendance).  The dip in 2011 can be attributed to a rare pull-back in film financing during the recession, so that the slate was weaker 2-3 years later, given the production cycle.  Pricing growth has tended to be more cyclical, but hasn’t seen y/o/y declines in more than two decades.

The slate should be supportive of a stable/growing box office for at least the next few years.  In the current quarter, things started slow, but Wonder Woman is performing well.  There are some tough compares in 3Q, but 4Q looks strong with Star Wars Episode VIII leading the slate.  Looking past this year, there is a strong group of tent poles hitting in 2018, and we have the Avatar sequel to look forward to a few years out.   

The exhibitors traded below their normal range during the 2009-12 period.  These businesses have historically traded in a range of 8-9.5x EBITDA, but the stocks are prone to wide swings in investor sentiment, and therefore valuation multiple.  We are currently in a trough multiple range.  I see AMC’s current <8x multiple as well below fair value, and it should be trading at a premium to the group. 

AMC: CAPITALIZATION

AMC trades at ~7.3x 2018 EBITDA, versus fair value in the 8.5-9x range.  Its FCF yield is in the mid-teens% on a pre-growth (maintenance capex) basis. 

AMC: RISKS

PVOD: Premium video on demand (PVOD) is an often referenced risk, which I believe is overblown in the market.  For years, there has been a fear that the theatrical exhibition window would collapse and lose share to home-viewing.  Theaters have exclusivity to show a film during the first few months of its public life.  After that, there are VOD and other less profitable windows that follow.  Given the growing interest in VOD, some studios have been pushing for the exhibitors to allow day-and-date (that is, day-1) PVOD viewing.  There have even been press reports suggesting the studios have discussed sharing PVOD profit with the exhibitors to achieve a deal.  For all the noise and its negative impact on AMC’s stock, I believe the emergence of a PVOD window concurrent with the theatrical window is quite unlikely.  First, the studios aren’t even in agreement as to how this would work – notably, Disney is not even interested in PVOD (preferring to maintain the exclusive theatrical window).  Second, this is a consolidated industry and the Big 3 will each boycott and film that does not grant them exclusivity.  Third, the studios and theaters are far apart on any kind of PVOD profit sharing agreements.  Adam Aron speaking last month: “…sitting here today with another industry issue.  We certainly appreciate the studio’s point in all of this - what I’m not seeing in the PVOD discussion is a coalescing around an industry solution.  There’s a lot of talk, and there’s not even a complete agreement among the studios as I read about it.  Not all the studios are convinced it’s a right thing.  So you don’t even have consensus on that side of the camera, and there’s certainly no consensus around an industry solution.  So, there’s a lot of work to be done if in fact there’s some form of premium VOD.  What’s different in this go-around is there is some discussion of compensation for the distributors if there were some cannibalization of our window.  But after 14-16 months of talking about this, I don’t see movement toward a solution.  So, that’s kind of my take.  I don’t want to handicap it.  But that’s an issue that needs to be resolved if we’re going to move forward constructively… [re the question of third party mediation] I kind of doubt it.  Studios and exhibitors need to work together and figure it out.”  Bottom line: I do not see this as a significant fundamental risk, and its more noise than anything. 

Leverage: Mgmt has over-extended its balance sheet.  At just under 5x EBITDA, leverage needs to come down – period.  This will happen through EBITDA growth, and I believe mgmt plans to scale back its capex plans given challenges in monetizing NCMI’s stock (at the levels they had original planned). 

Capital Allocations: Mgmt has a strong investment opportunity to continue its renovations and invest in recent acquisitions.  However, I believe they have been too aggressive both on the M&A front and in their capex plans.  They also erred in being so vocal regarding their intentions to use NCMI stock as a source of funds, which certainly contributed to that stock’s declines.  While I believe mgmt will proceed more conservatively going forward, there is some risk of not moving quickly enough to resize capex plans and halt further M&A.  

CONCLUSION 

Both NCMI and AMC appear dislocated currently and offer significant upside with mitigated downside.  Ultimately, I believe exhibitor stocks have emerged as a rare pocket of value in the current market, and I see 50-60% upside for NCMI (from its 12% yield and multiple expansion back to a SD% divi yield) and >70% upside in AMC (from EBITDA growth and multiple expansion) over the next 6-12 months.  AMC mgmt sees upside too and has bought ~$350k worth of stock in the past week.  RGC (short) offers itself as a decent box office hedge, given its relative outperformance and the Anschutz overhang.  

DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.

Catalyst

Secondary of NCMI stock by AMC, or sale of entire NCMI enterprise

AMC mgmt provides more conservative capex guide on 2Q call

Box office continues to grow, driving EBITDA growth for AMC

Valuation multiple mean reversion as technical pressures dissipate