Description

AMC is a short because:

a) US box office is about to peak in 2019, for forever

b) its #1 supplier (DIS) is merging with its ~#4 supplier (FOX), significantly increasing DIS’ market share from ~1/4 to ~1/3, which increases film rent expense at AMC

c) major studios such as DIS and WarnerMedia are launching direct to consumer “over the top” movie apps at 2019YE, which should lower the amount of films to be monetized through theatrical in the future, as well as significantly increase the risk of a shortening theatrical window

d) AMC Stubs A-List, its subscription program akin to MoviePass, is cannibalistic to existing sales and burdens the AMC P&L with

e) net leverage at 6x with no deleverage plans, already exhausted all sale leaseback / asset sale options

f) negative FCF for the past few years despite ever record box office environments

Historically, the way to trade exhibitors has been to short them on theatrical window / terminal value concerns causing multiple de-rate (like in 2017 with premium video on demand, and the subsequent subsiding of such concerns on the long side), and on box office numbers revisions (like in 1H18 when it became increasingly clear that Black Panther and Avengers: Infinity War would significantly outperform estimates).

Going into 2019, the trade is to short the exhibitors (both CNK and AMC) trading on peak multiples (8x EBITDA and 7x EBITDA are their historical relative highs) on a peaking US box office that may very well be peak box office – not just for this economic cycle, but for forever. Multiple significant events in 2019 are poised to alter the industry for forever: DIS/FOX merger, studios going DTC – both of which would structurally alter economics for the exhibitors for the worse. For AMC in particular, given it has net leverage close to 6x EBITDA, it’s not too crazy to assume a 1x or more EBITDA contraction if street is convinced that we are indeed facing forever peak box office and a challenged terminal value. As a thought exercise: investors are willing to value challenged cable nets like VIAB and AMCX at ~6.5x EBITDA and broadcasters at ~7x EBITDA despite them continuing to grow advertising and affiliate / retrans revenues for some time until the bundle breaks. Exhibitors trading at 8x (CNK) and 7x (AMC) by comparison are complacently valued. I think once investors realize that exhibitors will peak earnings earlier than cable nets and broadcasters and that the peak year is in 2019 – that would force several EBITDA turns of contraction. The levered play here to express the multiple contraction is AMC at 6x net leverage (vs. CNK at 2.5x). AMC is trading at 7x EBITDA currently. I think there’s a likelihood that equity could be worth close to zero with some multiple contraction.

----------

DIS / FOX: with China approving the merger earlier today, DIS / FOX received the last regulatory greenlight to consummate the merger. With the 20th Century Fox studio under DIS, DIS’ market share is poised to increase from ~1/4 to ~1/3.

Under Disney ownership, 20th Century Fox studio’s output can manage the box office calendar better with Disney so as to stagger hits on nonconflicting times, as well as bargain for a higher film rent split from the exhibitors. See below how a more concentrated office results in higher film rents.

Next, studios such as Disney and WarnerMedia are launching their own over the top apps by year end 2019 as counterweights against NFLX. While tentpole releases are still likely to be shown through the theatrical window, it’s likely that the mid and lower budget movies would not be shown through the box office at all, instead opting via their OTT apps. For example, Disney announced that their “Lady and the Tramp” remake will only be distributed via their OTT app, Disney+, and not through the theatrical window. As we progress through 2019 and 2020, it’s likely that Disney and WarnerMedia would announce an increasingly high amount of films to be distributed via only their OTT. Removing mid to lower budget films from the box office have two negative effects for the exhibitors: a) total gross box office is likely to decline over time as the number of films available at theaters decline, and b) an increasing concentration of films at the box office towards only a fewer number of tentpole films increases supplier power and raises film rents.

Tentpole releases on the other hand are unlikely to shift away from the theatrical window, given theatrical showings monetize better than OTT (if a family of four watches a Star Wars movie, all four members buy $10 tickets each, vs. if the same family watches the film on Disney+ on one $[10] monthly subscription). However, even such tentpole films are likely to pose a risk to exhibitors over time. Fox’s and Universal’s output deals to HBO are set to sunset around 2022. Given studios are trying to reorient themselves closer to the consumer with an OTT offering, there’s a high likelihood that Fox (via Disney) and Universal would rescind such pay 1 output deals from the market and distribute via their OTT platforms instead. In this scenario where studios are increasingly pulling back their library and output away from third party distributors and making it exclusive on their own platforms, the windowing transforms from:

Status quo: Theatrical > TVOD / DVD > pay 1 > cable / broadcast > pay 2

… to that of…

Possible future: Theatrical > studios’ OTT apps

In this world, the studios are incentivized to shorten the theatrical window as short as possible from the current ~90 days so as to get their latest films into the OTT apps, which the studios recognize as their growth engine in the future. Currently ~80-90% of box office ticket sales are monetized via the first 4 weeks of theatrical. From an economic perspective, there is no reason why theatrical windows need to be 90 days other than the fact that the oligopolistic exhibitors demand it; they know that a shortened window is an existential threat since consumers are much more likely to opt to wait to watch movies at home on TVOD if theatrical windows were shortened to say, 1 month. Studios never had the incentive to significantly shrink theatrical windows (not even during PVOD discussion days). I think 2019 will be the year where studios, spearheaded by Disney/Fox and Warner, finally try to shorten the window to sweeten their OTT’s value proposition.

----------

AMC in particular face additional idiosyncratic issues: Stubs A-List, 6x net leverage with no remaining deleveraging levers, and negative FCF despite record box offices year after year.

Stubs A-List is AMC’s form of MoviePass, where consumers pay $20-22 per month to watch an essentially unlimited number of movies. The economics work like this for AMC: a consumer pays $20 to AMC and watches 4 movies during that month. AMC pays ~50-55% film rents to the studios based on an assumed ~$10 ticket price, or $20 to the studio (4 movies * $10 ticket * 50% film rent). AMC would make zero profit from this consumer. The timing of the AMC’s Stubs A-List launch during summer 2018 coincided with the start of the demise of MoviePass, which started restricting the number of movies consumers can watch per month. While MoviePass bled subscribers, Stubs A-List absorbed those subscribers. These are not high NPV subscribers that AMC wants to take away from MoviePass. These are frequent, negative NPV moviegoers. Additionally, this is a bad trade for AMC. MoviePass pays full ticket fares to exhibitors and AMC experience variable upside with more frequent moviegoers, while under Stubs A-List, AMC takes on the full burden of frequent moviegoers. Management told us during the 3Q18 call that the moviegoing rate has started declining since launching during summer 2018, towards their target moviegoing frequency of 2.5x / month which will help them generate accretive earnings from the program, but don’t be fooled. September and October are the lowest seasonal months for moviegoing. November and December are the highest seasonal months for moviegoing, meaning they didn’t have visibility as to whether moviegoing was declining to a sustainable level during their 3Q18 call held in early November.

Cash flow situation - they haven’t generated any positive FCF over the past 7 quarters (besides the 3Q17 working capital benefit). [looking at this time period because they’ve done acquisitions beforehand]. This is despite 2017 and 2018 being record box office years! How would AMC fare in 2020 and beyond if we are right in that box office peaks for forever in 2019?

Their 6x net leverage is a big issue. They’ve done all the sale leasebacks they could execute. They wanted to sell Odeon, their European cinema business, by IPO-ing a stake during 2H18 / 1H19, to help delever, only to announce on the 3Q18 call that this would get pushed to 2H19 / 2020, if at all, given poor financial performance at Odeon. If poor financial performance is the reason for pulling the IPO, I don’t think the passage of time would help Odeon as studios increasingly go DTC over time and pull films away from the box office.

Lastly, AMC management are not good capital allocators. They recently levered up from 5.5x to ~6x net leverage by issuing a convert to Silver Lake and using proceeds for a dividend recap and repurchased shares from Wanda (to provide them for an exit). Very irresponsible when they have already been persistently generating negative FCF.

Without any more asset sales to help delever from 6x net leverage and a persistently negative FCF profile, faced with a potential forever peak in box office in 2019, suppliers consolidating and suppliers circumventing around theatrical to launch DTC, I think AMC is a compelling short at 7x EBITDA.

Catalyst

DIS/FOX merger, launch of OTP services, time.