Description

Cinemark (ticker: CNK, “the Company”) operates a circuit of movie theatres across the United States and Latin America.  With the stock at ~$40, it’s a $4.7bn market cap company with a ~$6bn enterprise value (adjusted for unconsolidated assets) that trades ~$60mm / day.  They operate ~340 theatres domestically (80% of revenue, across 41 states but with a substantial presence in Texas and California) as well as ~205 theatres in Latin America (20% of revenue, across 15 countries with leadership positions in Brazil, Colombia, and Argentina).  The short thesis is predicated on the ‘age old’ premise that movie theatres are getting disintermediated, which is not going to happen overnight, but when combined with several near-term dynamics that could negatively shape the trajectory of earnings as we move into 2020, it makes for an interesting setup on the short side.  These factors include: 1) studio consolidation, 2) OTT / streaming competition, 3) box office comps into 2020, 4) a waning innovation cycle in terms of experience, 5) limited additional pricing power, and 6) an extrapolated set of positive expectations into 2020.  When you combine these factors with the additional ‘optionality’ that the theatrical window is shortened, or some releases are distributed directly via premium video on demand (PVOD) on a stock that is trading at a full/market multiple, the result is an asymmetric opportunity to short the shares.  Specifically, a scenario that sees domestic attendance fall back to ~180mm in 2020, in-line with pre-2018 levels (before the heroic slate, pun-intended), pencils to ~$2.00 of 2020 EPS or a $30 stock at 15x (~25% downside) compared to a less likely $2.80 of 2020 EPS (+20% from 2018’s anomalous year) or a ~$45-47 stock at 16-17x (+15-18% upside).  Moreover, the short really pays out if the aforementioned PVOD option is back on the table where several turns of the multiple are likely to come out of the stock rather quickly.  In summary, Cinemark’s movie theatre business is in secular decline from an attendance perspective and the stock is embedding a continued healthy/growing earnings stream while seemingly ignoring the changes taking place with its suppliers/customers and where the entertainment landscape is heading.

Taking a look at these factors in a little more detail, there are a couple big changes occurring that are worth contemplating.  First, several mergers have taken place that may impact film rents as well as potential changes to the theatrical window.  There are six major film studios: Buena Vista (Disney), Warner Bros (AT&T), Universal (Comcast), 20^th Century Fox (Fox), Columbia (Sony), and Paramount (Viacom).  However, the recent Disney + Fox merger is reducing this effectively to five and Disney’s share will go from low 20’s% to mid-30’s%.  Now controlling one third of the theatrical box office, Disney will likely flex their muscle in upcoming film rent negotiations and will have a critical role in determining the future of the theatrical window.  Further, AT&T’s recent acquisition of Time Warner may begin to have an impact on similar negotiations with exhibitors.  Disney is slated to release their new OTT product later this year, and both Disney and AT&T are looking to bolster their OTT/streaming products, potentially diverting some content toward streaming assets and pushing to change the windowing terms.  Better streaming content available direct to consumer in conjunction with shorter wait times to see theatrical releases at home is likely to pressure attendance in the coming quarters/years.  Beyond the consolidation and potential windowing changes dictated by the studios, the competition from high quality on-demand TV as well as full featured movies is accelerating.  Netflix is now releasing a new full-feature movie every week.

Finally, the ‘experience’ that exhibitors offer consumers and the overall value proposition is just no longer that compelling.  While the threat to movie theatres has been debated for decades with the introduction of VHS in the 1980’s, things really are different today.  Back then, a big screen TV was something like 30-inches and the picture/sound quality at home was noticeably worse.  Today, you can buy a 70-inch high definition TV on Amazon for under $1000.  Moreover, high speed data connections today have enabled these home theatres to have access to virtually an unlimited amount of incredible content on-demand.  Going to the movies used to actually be a novel experience (the latest/best content delivered by an immersive big screen).  Today, a consumer can recreate this experience in their living room (or frankly on their smartphone).  Theatres have recognized this and have tried to upgrade their facilities with reclined seating, but this offering is not really something new/innovative that consumers will pay up for and is simply trying to match what the consumer now requires and is accustomed to at home.  With average tickets at ~$8 and concessions at ~$5 per person, a family of four going to the movies now costs close to ~$60.  So while consumers may still show up for the occasional superhero blockbuster, trips to the movie theatre are becoming harder to justify.  Already spending the ~$10/month for Netflix at home, it’s no wonder more people now prefer to just Netflix and chill.

The setup at the box office is also challenging as we move through the year and into 2020.  2017 saw domestic attendance decline ~5% despite having successful releases from the Star Wars franchise, Beauty and the Beast, and Wonder Woman.  This setup a great 2018 for the exhibitors, especially with juggernaut releases like Black Panther, Avengers, and Incredibles 2, each which did over $600mm in the box (compared to just Star Wars exceeding $600mm in the domestic box in 2017).  One of the other factors driving growth in 2018 was MoviePass.  This was a service launched by Mitch Lowe, a former Netflix executive, who aimed to apply the Netflix model to movie-going by offering a $10/month subscription for the ability to go to the movies up to once a day.  Having amassed several million customers going into 2018, MoviePass added an additional tailwind to 2018 attendance.  Moving into 2019, the Q1 box office is going to be down mid/high teens vs last year due to Black Panther.  While the rest of the year does have a solid content line up (Avengers, Lion King, Star Wars, Frozen 2), consensus is already modeling a HSD increase year-over-year.  Further, the tailwind from MoviePass is gone with the Company folding its unlimited subscription offering late last year after running into financial distress.  So while it’s possible the content line-up may perform in the back half, the street is already there, the bar is high from 2018, and the setup going into 2020 will be extremely tough (not as many obvious blockbusters).         

Overall, Cinemark’s movie theatres are poised to see pressure on attendance as well as on the economic arrangements they have with studios.  It’s a higher bar in terms of content to get consumers to make the trip to theatres, there is an ever-increasing array of competitive video on-demand in the home and on mobile devices, and studio consolidation will hurt theatre’s bottom lines.  The stock is trading at a full/market multiple and expectations are elevated in 2019 (somewhat justified) and into 2020 (hard to justify).  Cinemark is not a fraud that’s going to zero, but it’s an interesting asymmetric short that should generate alpha vis-à-vis the market over the next 12-18 months. 

Key Considerations

·         Streaming competition: new Disney OTT product launching, Netflix releasing weekly full feature movies

·         Shorter window / PVOD: Time Warner and other studios looking to shorten the window and go direct

·         MoviePass: tailwind bolstering last year results has created tougher comps for 2019

·         Box office setup: 2018 box comp is tough, 2019 has strong releases, but 2020 may be setup for declines

·         Consolidation of suppliers: Fox + Disney now control ~35% of box office and likely pressure economics

·         Valuation: trading at market multiple but has anemic top line growth and persistent secular pressures

·         Balance sheet: headline screens ~2x leverage but closer to ~50% levered on a lease adjusted basis

·         Attendance declines:  box office has grown LSD but based on pricing while attendance has been anemic

·         Competition for time/entertainment: high quality video games, OTT/streaming, mobile devices

·         Unfavorable film rents:  tent pole economics favor studios not exhibitors, studios take bigger share

·         ‘Innovation’ cycle over: reclining seats + food and beverage upgrades are largely played out

·         Value proposition:  the cost of attendance is challenging to justify given home theatre improvements and streaming content offerings

Risks

·         2019 slate:  the upcoming slate for the remainder of 2019 is uniquely strong and 2019 exceed estimates

·         Healthy international growth:  Brazil, Colombian markets have been stronger following recent elections

·         FCF Improvements:  Capex cycle from recliner investment is winding down which could bolster FCF in near-term

Catalyst

·         Domestic box office: performance of releases with high expectations (Avengers, Lion King, Star Wars, etc.) 

·         Upcoming film rent negotiations: new economic splits with combined Fox + Disney

·         New windowing agreements / PVOD:  AT&T and others are pushing to shorten the window

·         New OTT/streaming products: Disney’s new OTT product may divert theatrical content