Description

We're short Cinemark.

The company operates movie theaters, which I expect requires little explanation to the average reader in terms of the product itself.

The basic economics of a move theatre operator are as follows. Revenue splits roughly 60/35/5 between tickets / food and beverage / other (basically on-screen advertising + online ticket fees). The two core variable costs are movie "rent" (what you pay to the studios to show their movie) and the cost of the food and beverage that you sell at the concession stand. Ticket sales come in at ~ 44% GMs (i.e. the studios capture ~ 56% of the ticket price) while food and beverage sales tend to generate ~ 84% GMs. The core fixed costs are - (1) rent, (2) labour (quasi-fixed), (3) utilities and (4) depreciation. In a typical year, rent is ~ 12% of sales, labour is ~ 10% of sales, utilities & similar are ~ 10% of sales and depreciation is ~ 8% of sales. Putting that together, theatres tend to make ~ 27% EBITDA marings and ~ 19% EBIT margins. Then there's another ~ 5% of corporate G&A that takes group EBIT margins to ~ 14%.

The numbers above refer to the US business of Cinemark. This makes up ~ 80% of total revenues/EBIT so and the LatAm business' P&L is structured slightly differently but not massively, so the group numbers look pretty similar to the ones I laid out above.

We think that Cinemark (and other movie theater businesses) are interesting shorts today as they currently face a confluence of ongoing structural pressure, waning pricing power, difficult compares, emerging axes of competition/disruption and OpEx pressures driven by wage inflation.

Structural Pressure

The US cinema industry has seen per capita attendance decline from 5.2 visits per person per year in 2002 to 4.0 today, down 26% over 16 years. If you consider this statistic on a 2y rolling basis (to control better for year-to-year slate volatility) it's declined every single year between 2002 and today.

The attendance declines have been most acute in the younger generations (portending further future weakness as these generations age and become a larger portion of the potential movie-going population).

Waning Pricing Power

From 1970 to today, the cost the average movie ticket (in today's money) has ranged from $7 to $9. We're currently sitting at the very high end of that historical range - suggesting to me that we may again be at the point where pricing power begins to wane. This hypothesis is corroborated by recent reported results from the big three listed chains (AMC, Cineworld & Cinemark). If you adjust for the impact of their recent recliner roll-out, I estimate that Cinemark ticket prices declined by -0.3% YoY over the LTM period. Far from disastrous. But also far from the clockwork-like 2-3% LT pricing assumption that bulls seem to assume for these names in their thinking/modelling.

Difficult Compares

The US slate has been very strong for the last couple of years, supported by Black Panther and the MCU. If you extrapolate the LT trend in per capita ticket consumption to 2019, it suggest we should be running at ~ 3.7. In 2018 it was 4. That implies that to revert to trend, we'd need to see attendance down ~ 7% YoY in 2019. That might be pushed out by a strong showing from Frozen & Star Wars in Q4 but the point is we're running above trend right now and I think it more likely than not we revert to trend at some point. When we do, it's going to be ugly.

There's a fairly widely held view that Disney is throwing all their content at the slate for 2019 to try and generate as much positive buzz around Disney content ahead of the Disney+ launch this fall/winter. Disney is by far the most important studio to the US box office at this point and as a result have left their (and the industry's) 2020 slate extremely bare.

Emerging Competition/Disruption

We're seeing an explosion of offerings in the OTT space today. Netflix, Amazon Prime and Hulu have now been around for a while but we're very shortly going to be looking at Disney+, AppleTV, HBO Max, Peacock (from NBCU). The movie theatres have survived the emergence (and success) of Netflix to-date but this time might be different for two reasons. First of all is the sheer volume of content that is going to be available on-demand is going to significantly increase. That content competes - on the margin - with moviegoing. That can only be a bad thing. Amazon is reported to be spending $1b on their LoTR series. That's "movie-quality" content not coming to a cinema near you. Netflix just released Scorsese's the Irishman. That's more "movie-quality" content not coming to a cinema near you. The next reason that this is bad for the cinemas is because, until now, none of the emerging OTT players have been tied to a movie studio. That means the incumbent movie studios have had no real pressure to change the way they do things. That's going to change. Disney+ is now the OTT arm of the company that owns the Disney & Fox studios. HBO Max is going to be the front of the Warner Bros content. Ditto for Peacock/Universal. These studios now have a much harder question to answer. Where is my content going to be placed to deliver max LT strategic and financial value to the group as a whole. Is it to recoup my budget and hopefully a bit more at the box office or is it to drive another few million subscribers to my OTT platform this money. Hard to say, but net-net it can only be a negative for the theatres to the extent that more quality content that would historically have ended up in theatres lands on the OTT platforms instead.

OpEx Pressure

This is a little bit of icing on the cake of the thesis but the reality is that Cinemark has faced recent minimum wage hikes in ~ 50% of their locations in the US. If you look at salary costs per screen, that number has risen by almost 10% (!) over the LTM period. If I'm right about the structural and cyclical pressures on the top-line, this level of rampant cost inflation is only going to make that revenue shortfall even more painful when it comes.

Putting it together, I think the stock probably does a bit less than $2 of EPS in 2020. The street is at at almost $2.5. If you put the business on 12x (seems reasonable for an ex-growth comapny with LT structural challenges and question marks over it's true terminal value) that's a $23 share price, down ~ 40% from here. Happy to discuss specifics on assumptions in Q&A.

Catalyst

- launches of various OTT platfroms in 2019/20

- people stop focusing on Frozen & Star Wars and start focusing on the weak 2020 slate 

- Cinemark loses share to the "all you can eat" plans that are now out there from AMC & Regal