Description

Business Description

Cinemark (CNK) is the #3 theatrical motion picture operator in the US, with 345 theatres and 4,645 screens in 105 DMAs across 42 states. CNK also operates 1,487 screens in Latin America including Brazil (633 screens, #1), Colombia (207 screens), and Argentina (197, #1). 

CNK generated $3.28 billion in total revenues (79% domestic) and $745 million in Adj. EBITDA (83% domestic) in 2019. CNK invested $303 MM in capex in 2019 (76% domestic).

CNK’s $1.4 billion in US box office revenue in 2019 represents ~13% market share of the North American (US/Canada) box office. CNK ranks third behind AMC ($2.4 billion) and Cineworld (which acquired Regal in 2018) at $1.9 billion in the US. 

LT State of Industry (Pre-Covid): 

The long-term challenges facing the industry have been well covered. But I would argue that prior to the coronavirus epidemic, CNK had maintained an attractive business despite moderate secular headwinds.  

Industry-wide, NA movie attendance has averaged ~1% annual decline over the past 10+ years, though attendance is more variable year-to-year ( +/- ~5% std. dev.), driven by film slate quality with minimal to no macroeconomic sensitivity. This has been more than offset by average ticket price increases (~2%), with NA box office revenues increasing +8% over the 10 years from 2009 to $11.4 billion in 2019. The 2018 record haul of $11.9 billion represented +24% over 10 years earlier. 

The top theatre circuits have also been driving profit growth through improvements to their F&B offerings (coffee, alcohol, premium food, etc.) and greater price increases. CNK grew concessions per capita by 9% (constant currency) in 2019 and 6% in 2018. Concessions are extremely high gross margin (80%-plus) and now account for nearly 50% of CNK’s gross margin dollars. The top circuits have also been in a high capex cycle until recently as they upgraded seating, driving higher ticket price growth and initially high (but diminishing) ROI. CNK has re-seated ~60% of its circuit to wider recliners. 

CNK: Historically Outperforming, Conservatively Run

CNK has consistently outperformed the industry on attendance and financial performance, reflecting industry-leading attendance per screen, superior operating efficiency including lower-rent, high-ROI locations, relatively conservative approach to growth capex, and avoiding overpriced M&A. Through 2019 CNK posted +4% to +5% 5-year CAGRs on revenue, EBITDA, and FCF off 1% attendance CAGR.

The business’ underlying return on capital profile has remained attractive, in contrast to the negative perception of the industry. On a down year in 2019, CNK generated pretax return on net tangible assets of >25% (cash basis; gross PPE) or >20% (RONA, inc. D&A) depending on the chosen metric. Capitalizing lease liabilities, pretax ROIC has still hovered around 17% or higher. Backing out excess cash, ROE after tax was nearly 20%.

These returns reflect CNK’s operating efficiency and hints at what has been the bigger issue in the industry in recent years: value destructive capital deployment (overpriced M&A, excessive debt-driven buybacks at high prices and dividends). CNK management has been more conservative than its peers when it comes to M&A, leverage, and buybacks, and has avoided the worst of these issues. Since acquiring Century Theatres in 2006 and completing its IPO in 2007, CNK’s only significant acquisition was Rave Theatres for $237 million in 2013. Including acquired goodwill and intangibles, pretax ROIC falls to ~17%.

Comps Deep Dive Post-Covid Impact

Now onto the more pressing concerns: with theatres shuttered since March 18 and an uncertain path forward, how is CNK even investable? Or anything but a beta bet on covid-19 trends?

I believe the latter question could be applied to much of the market, but key details here are CNK’s relative operating strength and discounted valuation versus peers. CNK has an industry-low valuation despite superior operating returns, the lowest leverage and strongest liquidity position (by far). Below I highlight key statistics of the four leading North American theatrical operators, including dominant Canadian circuit operator Cineplex (TSE: CGX). 

Balance Sheet Analysis

Note: CGX has pending a $34/share cash takeover by Cineworld. Despite shareholder approval, the deal is highly unlikely to be completed on agreed-upon terms, as reflected in the deal spread. There are multiple reasons: CGX likely to exceed debt limits specified in the merger agreement by the outside date of June 30; even with financing, close could push Cineworld toward bankrupt; Canadian authorities are unlikely to approve if Cineworld not a deemed viable acquirer. 

CNK entered the crisis with $1.5 billion in net debt ($1.6 billion as of March 31), or 2x 2019 EBITDA, compared to 3.4x at Cineworld and an already distressed 6.1x at AMC. On top of that, CNK has much more limited theatre lease exposure than these peers. Cash lease expenses were 10% of revenue in 2019 (14% CINE, 17% AMC) and capitalized operating leases total $1.4 billion or 1.9x EBITDA (4x at CINE, 6.4x at AMC). This reflects CNK’s location choices, some owned real estate (43 of 345 theatres in US), and shorter average remaining lease terms than peers. Standardizing discount rates (CNK uses <5% discount rates and AMC applies 7.2% to capitalize operating leases, CINE up to double-digits pretax) would create an even starker difference. 

Liquidity Stress Testing

CNK has held significant excess cash on its balance sheet for years, and after issuing another $250 million in secured bonds at 8.75% due 2025 (with 2022 trigger under certain conditions), CNK had ~$700mm pro forma cash on hand to endure the shutdown. 

Below, I have estimated monthly cash burn for CNK and the peer group while theatres are shuttered. I assume CNK can eliminate ~80% of salaries and wages, 60-65% of utilities and other facilities costs, and 25% of G&A. With film rental and concessions costs variable, the biggest operating cost item is rent (45% of operating cash burn per my estimate, in line with CNK’s estimate at 40-45% of total cash burn). I assume no rent relief, though CNK is negotiating deferral of payments with landlords. After interest, monthly cash burn comes to ~$80 million. Ongoing non-rental operating expense rates for the comps use similar assumptions.

These estimates imply CNK has enough cash on hand to cover ~9 months of zero revenue, putting aside rent relief, tax benefits from the CARES Act, additional employee furloughs/wage cuts, further capex deferrals, etc. This compares to <5 months for the peer group. Even after 9 months, CNK’s net leverage would be at 2.5x 2019 EBITDA, suggesting meaningful incremental borrowing capacity if needed barring the worst case 2021 outlook.

Relative Valuation

CNK shares are down ~65% from their peak and have recently traded in a range centered around 4x 2019 EBITDA, with the multiple rising by ~0.5x assuming 4 months of theatre closure. This represents 2-3x EBITDA turn discount versus AMC and CGX. Cinemark trades at only a modest discount to Cineworld, Cineworld’s downside risk looks far scarier given the liquidity position and debt profile. True, CINE will likely have a higher beta to the upside as well, if the box office rebounds faster and stronger than expected. However, even if theatres reopen with reasonably strong attendance in July, 4x leverage and covenant challenges will create a difficult situation for Cineworld. CINE should expect significantly higher borrowing costs and lower FCF going forward (CINE currently paying ~4% cost of debt). In the most bullish covid scenario, in which CINE and CGX are actually able to close the deal, this could be a disaster for CINE equity. The all-cash deal values CNK above 11x 2019 EBITDA (pre-synergy), and slightly higher with the subsequent cash burn. CINE’s net debt would approach 5x pro forma 2019 EBITDA if the deal closed on June 30. 

CNK Best Positioned to Capitalize on Industry Restructuring 

The current crisis could perversely benefit CNK in the long run given its superior financial position. The above analysis suggests AMC or even CINE could run out of cash by the end of July, leaving almost no room for error if the current plan for fresh theatrical content to return to theatres in mid-July is delayed or attendance does not materialize. CINE may have some incremental borrowing capacity, but its current low borrowing rates should rise drastically and the equity value could be materially further impaired. AMC was already teetering toward restructuring even before covid-19, and now this looks like a virtual certainty (barring the highly suspect Amazon white knight rumors). Smaller competitors are at even more elevated risk of permanent closure.

In a bankruptcy, we should see selective theatre closures and sales. CNK will benefit substantially from the closure of any competing theatres in its footprint; competition is local, and local screen density and market share are key determinants of property-level profitability. The closure of competing theatres means higher attendance and greater pricing power at CNK theatres. CNK could also be the only US operator in position to capitalize on distressed opportunities to selectively snatch up attractive leaseholds or even buy smaller competitors. 

I would not understate the potential impact of these dynamics. The megaplex theatre construction boom in the 1990s produced a wave of bankruptcies which led to rationalization of theatre counts in the US and improved the economics of the surviving industry. Regal itself was born out of Phil Anschutz’s plan to combine 3 bankrupt chains in 2002. AMC seems almost certainly destined for bankruptcy (save a white night from Amazon which seems to lack credibility), and Cineworld could even follow if the downturn proves extended or they somehow manage to complete the Cineplex acquisition. 

Covid-19 Thoughts

I will leave the broader covid-19 discussion outside of the scope of this report, rather focusing on CNK’s relatively favorable position within the industry to pull through. But I will try to briefly address the glaring question, whether the virus has permanently disrupted the movie industry via structural supply (more direct-to-consumer, PVOD) or demand (consumer avoidance of theatres) changes.

From a demand perspective, the virus alone should not permanently alter consumer predisposition to attend the cinema. Common sense and the exhibition industry’s rebound from SARS and other viruses, even Spanish flu suggest otherwise. 

The strongest argument for permanent impairment to the industry is that it is accelerating the movement of feature content to VOD platforms, including PVOD. The most high profile example to date was Universal’s successful release of Trolls 2 (World Tour) straight to PVOD for $20 on April 10. Trolls has pulled in more than $100 million, likely netting Universal as much or more than projected box office (domestically) and as much as the 2016 Trolls brought in domestically ($154 million box office, ~50% to Universal versus ~80% for PVOD). Disney and Warner have also rescheduled a few films to direct digital release. 

The trend of Netflix et al increasing movie spending predates covid-19, and in general SVOD and other home entertainment alternatives have almost certainly been a factor in the slight decline in attendance over the years. This headwind remains, and may accelerate marginally post-covid, but although the more recent studio decisions have created enormous buzz, I would not overly interpret them. Trolls pulling in a bit more than the anticipated box office revenues from PVOD is a good outcome, but the environment in which it was released—a nationwide lockdown, zero competition for fresh content from theatres or alternative PVOD releases—is absurdly far from replicating normal conditions. And do not forget that international box office is now bigger than domestic, and PVOD unlikely to be as successful there. Disney’s two titles shifted to PVOD were not that high up its 2020 slate. Artemis Fowl was already delayed by a year and has no proven consumer pull. Hamilton is actually a taped recording of a Broadway performance, not a traditional musical film, and the $75 million price tag for global distribution rights suggests they did not expect true blockbuster potential. These moves reflect a need to de-clutter the post-covid slate and to build an audience online for new services, especially when the normal window flow is disrupted.

More likely than huge disruption, we continue to see some content with limited box office potential (sub-$100-$150MM or so domestically) and narrow addressable audiences shifted online, when it may actually make economic sense. The exclusive theatrical window will also continue to shrink. This is not revolutionary. Window shrinking and at-home alternatives have been themes for decades. Tentpole content already dominates the big screen (>$300MM grossing films contributed ~50% of box office in 2019), limiting the impact. Disney, which after the Fox acquisition contributes up to ~50% of box office receipts, is firmly behind the big screen and not shifting blockbuster content. Superhero franchises and digital masterpieces like Avatar (3 sequels to the then-top grossing film of all-time planned for release over the next 5 years) will remain must-see on the big screen. As AMC has publicly stated, exhibitors are likely to boycott in the unlikely case that PVOD is used with big titles when theatres are actually open, without compensation.

Clearly, there will be an intermediate stage with reduced attendance if studio content returns in July as currently planned (or whenever reopening). But there should be some counterbalance from the glut of tentpole content coming in 2H 2020 and 2021, which is only partially due to the delay of 1H20 content. In fact, some investor/sell-side (misplaced) discussion has even centered around the risk of box office cannibalization from the excess of content. 

Despite these doubts as to whether coronavirus really changes the long-term attendance trends, I think building in a ~5-10% permanent reduction to movie attendance in the “new normal” (post-2020 or ’21) due to more DTH release and modest permanent decline in consumer affinity for theatres is prudently conservative, and still leaves upside for CNK. 

Capacity Restrictions Manageable, CNK Pricing Power

In the interim, theatre capacity restrictions for health purposes are a concern. The risks look modest, as theatres are rarely full; even CNK’s leading US attendance equates to 104 attendees/day/screen. Pre-booking can smooth admissions if we are so fortunate to run into that issue this year, but if we do, I do not think that this concern will be investors’ top of mind…

CNK also has greater latent pricing power to make up for attendance declines (in the medium/long term) than AMC and Regal. Part of CNK’s operating strategy has been to maintain average ticket prices ~10-20% below the other chains, with selective heavier discounting (e.g. “discount Tuesdays”). This strategy has worked with 30-40% higher per-screen attendance than AMC and Regal, but could be reversed if we see less elasticity of demand and a small portion of former theatregoers (e.g. 5-10% referenced above) exit.

Geography May Be Advantage

CNK’s geographic footprint may be an advantage during the reopening. CNK’s largest circuit footprint by state is Texas (30%), California (20%), and Ohio (6%). CNK’s circuit is generally positioned in more suburban areas, and CNK is unexposed to NYC, whereas AMC and Regal both over-index to NYC and major metro areas generally. Texas has been one of the most aggressive states in reopening, with theatres already allowed to open for several weeks on a state-level legal basis. Of course, there are risks that the less affected areas become new hotspots in a second wave. But broadly, CNK’s more suburban footprint should be an advantage in attracting visitors in the early months of reopening.

I have left aside the Latin American operations given the relatively small size. In short, they face similar dynamics, plus currency devaluation and probably greater macroeconomic headwinds. But most costs are in local currency which will limit cash burn in the interim. Long term, the industry is still underpenetrated in these regions, providing higher growth prospects. A sale is also possible, as Cinemark exited its Mexico operations previously, for example. 

Valuation:

CNK shares are down ~65% from their peak, though doubling from the March lows. But at 4x 2019 EBITDA, my projections suggest there is still an attractive risk-reward in the shares without assuming a recovery to pre-covid earnings or valuation multiples. For reference, CNK traded fairly tightly around 8x EBITDA prior to the crisis, although falling to ~6.5x as the late 2019 box office weakness developed. Transaction comps are well into double-digit EBITDA multiples, FWIW.

In my base case, I assume a (75%) drop in attendance in 3Q19 and (25%) in 4Q19 (off weak comps), more akin to reaching the intermediate-term normal in September rather than July. This produces an estimated ~$400 million cash burn for CNK in 2019, exiting the year with $1.9 billion in net debt or <3x pre-Covid EBITDA. This leaves ~$360 million cash cushion which as noted should cover total theatre closure until the around the end of 2020 in a downside scenario, before incremental cash conservation measures and tax refunds.

Clearly, the “new normal” could produce lower theatre attendance and financial performance, and a lower multiple. One can debate whether CNK will eventually rebound to mid-single-digit topline and operating earnings growth rates longer term. But for conservatism, in the base case I assume a ~15% structural hit to ongoing EBITDA post-Covid, some rationalization of capex for a mature business entering a “capex holiday” of sorts following theatre seating ugrades (to 4-5% of revenue, ~10% of net PPE). Assuming 0-2% LT revenue/cash flow growth, 8-10% cost of capital, the corresponding EBITDA multiple is ~7x. At 7x 2021 EBITDA of ~625MM, and the aforementioned cash burn rate, we get to $22/share base case implying ~60% upside. 

Pushing out this muted recovery another year still presents close to 50% upside, assuming the business can at least get to cash flow breakeven in 2021. In a bull case with CNK’s earnings fully rebounding in the coming years (possible under the right conditions even if the broader industry does not fully rebound), we get to ~$28-$30 or >100% upside even assuming the same low/no terminal growth multiple (7x). For the bear case, one would need to assume ~25-30% permanent EBITDA decline, ~5.5x terminal EBITDA multiple to start to get below $10/share in equity value. 

CNK shares have rallied in recent weeks and are no longer at “no brainer” levels <~$10/share, but the above risk-reward tradeoff still looks compelling. Long/short investors also have multiple avenues to lay off some of the macro risk and isolate CNK’s relative discount/more favorable operating and financial position. The AMC equity stub is basically not borrowable but there are some possibilities with options. Logical could be also shorting a mix of CGX, CINE (in proportion to the est. probability of a CGX/CINE deal close, [which is low], as I think the deal would be severely value-destructive to CINE), and even screen advertiser NCMI which is doubly leveraged to attendance and ad CPMs (plus reserved seating impact) without CNK’s pricing lever or variable costs.  

Catalyst

-Reopening of theatres and end of cash burn; eventual rebound in attendance

-Possible bankruptcy of competitors and improved competitive environment

-Market correction for relative valuation discrepancy