Description

Overview

The original Cineplex idea was posted last July by mimval in the heart of the pandemic and pre-vaccine announcements when the company was trading at $8 per share. Today, Cineplex shares are trading for $12.50, but I believe the risk/reward is more favorable now as there has been a number of positive corporate actions and industry data points. Given the number of positive events (over and above the mass rollout of high efficacy vaccines), I feel a new Cineplex write-up is warranted.

Cineplex is the dominant cinema operator in Canada with ~75% market share. Today, its unlevered valuation is at a ~25% discount versus where it was trading pre-pandemic. Meanwhile, inferior industry peers and other “reopening trades” are all trading at higher valuations versus pre-COVID levels. Simply assuming Cineplex’s valuation reverts towards its historical level, I see ~50% upside in its share price. Assuming a valuation in line with global peers, one could argue the upside is even higher. Conversely, if this multiple expansion thesis does not play out, I still believe the downside is reasonable from this starting point as I see Cineplex trading for a ~8% FCF yield on normalized numbers. Cineplex has over 10-months of liquidity assuming zero revenues. Liabilities have been termed out by a recent 2^nd lien bond offering and bank covenants are waived until Q4-21, which is after when I expect Canada to emerge from the COVID-19 crisis.

Moreover, this valuation does not consider ~$400 million in the estimated value of non-core assets and a multi-billion dollar lawsuit out against Cineworld for backing out of its acquisition of Cineplex. Therefore, potential non-core asset sales represent upside of an additional ~35% from today’s share price, while a successful legal claim against Cineworld can represent an additional 100%+.

The ultimate catalyst here is line-of-sight to a full reopening of the Canadian economy. The reason this opportunity exists has to do with all Canadian reopening trades lagging as Canada is currently in a third COVID wave. Fortunately, recent data points suggest Canadian vaccine inoculation rates are catching up to global developed peers. Current inoculation rates are around ~1% of the population per day. Assuming this cadence can be maintained, the Canadian economy should be set for a full reopening come September 2021.

Cineplex trades ~C$7 million per day so this is an actionable idea for most managers on this board. I should also note, being long via short puts is a very attractive option given the high implied vol here. You can write $13 strike October 2021 puts for $2.25. This represents a 17% gross yield. Since this is a TSX mainboard listed security with a share price >$5.00, most brokers are giving >3x leverage on the name.

What notable corporate events have occurred since mimval’s July 2020 thesis?

1. November 13th, 2020, in Cineplex’s Q3-20 earnings report, management highlighted that Cineplex will receive a ~$60 million refund from the Canada Revenue Agency as a loss carryback
   
   
2. December 18th, 2020, Cineplex and Scotiabank announced an improved SCENE loyalty program launching in the fall of 2021. While the details of the arrangement are sparse, in the press release, Cineplex announced that Scotiabank will pay Cineplex ~$60 million
   
   
3. December 22nd, 2020, Cineplex announced the sale and leaseback of its head office building in Toronto, for gross proceeds of ~$57 million
   
   
4. February 26, 2021, Cineplex raised $250 million from a 2^nd lien bond offering to repay its outstanding credit facility and get the banks comfortable with their overall Cineplex exposure. Prior to this raise, Cineplex was under technical default on its bank covenants. Post this raise, Cineplex’s bank leverage covenants have been waived until Q4-2021. (Note: see the comment section of mimval’s original thesis, this was one of our biggest concerns at the time of mimval’s initial write-up)

In total, event #1-3 provide Cineplex with ~$175 million in liquidity. Cineplex has called out a monthly cash burn of ~$25 million assuming zero revenues. Therefore, these events fund seven months of Cineplex’s cash burn (assuming zero revenues). Meanwhile, event #4, firmly takes any sort of forced dilution effort from the banks off the table.

Worth noting, Cineplex’s share price rallied to ~$15 shortly after event #4 transpired, however as Canada entered its third COVID wave, its share price has retreated and lagged US reopening names. Fortunately, Canada appears to be catching up with other developed countries on its inoculation efforts and should be set for a full reopening by the end of September.

What are some industry data points that support strong reopening demand for cinemas?

     China

• IMAX declared that China’s box office in Q4-20 is already back at 2019 levels
• Detective Chinatown 3 released in China during the Lunar New Years set records with a ~US$670 mm in box office. However, this record has more recently been topped by Hi,Mom which did ~US$820 mm in the Chinese box office

Japan

• A domestic film called Demon Slayer had the biggest weekend ever in Japan – largely with 75% capacity limitations

     Other Asia

• Peninsula was a film that came out last summer and did record numbers in Korea, Taiwan and Hong Kong

US

• Cinemark has now cut deals with all top 5 studios – Universal, Disney, Paramount, Sony, Warner Bros. on streaming windows + splits. Terms have not been disclosed. But should be a positive – it indicates that WB is moving away from HBOMax Day and Date experiment after 2021.
• Netflix is also doing a wide release of its Army of the Dead film with Cinemark. One week window in theaters before it’s available to stream
• While cinema capacity constraints are still in full effect across the US, patrons that have returned to the cinemas have been spending. Food and beverage purchases up at AMC and Cinemark

o   AMC says concession spending per patron up 45% compared to Q1 ‘19

o   Cinemark says domestic food and bev per patron running at all time high in excess of $6 per patron

Cineplex’s valuation?

Cineplex’s cinema attendance peaked in 2015. From 2015 to 2019, attendance declined ~4% per year. Cineplex has been able to manage this attendance headwind with price increases and higher concession revenues per patron, resulting in total cinema segment revenue to grow 1% / year since the attendance peak. I expect similar trends going forward, with modest attendance declines being offset by similar price increases, resulting in overall stable box office revenue and EBITDA trends.

2019 EBITDA adjusted for lease costs was $230 million. I believe this is a reasonable normalized estimate going forward. Effectively this assumes stable go-forward box office trends and structural cost improvements taken during COVID are offset by items to improve overall liquidity.

The traditional cinema business (referred to by the company as “Film Entertainment and Content” segment) and the ads played before a movie (part of the company’s “Media” segment), represents the vast majority of the business with ~80% of total 2019 revenue and I estimate ~100% of operating profit. As per the other segments (which include a digital sign business, an adult arcade concept and an arcade distribution business), I don’t want to spend much time discussing them given their infancy / lack of profitability. However, it’s worth noting that despite their lack of profitability, the street carries these businesses at a relatively high multiple in their sum-of-the-parts valuations. For example, Scotiabank estimates these non-core businesses to be worth more than ~$400 million, which is ~35% of Cineplex’s fully diluted market cap. Again, I assign no value here but do want to flag the additional upside.

Also, as mimval suggested in the initial write-up, there is a multi-billion dollar lawsuit outstanding against Cineworld for backing out of their acquisition of Cineplex. I’ve assumed zero value, but a successful settlement could well in exceed the current fully diluted market cap. Court hearings are expected to begin in September 2021.  

Enterprise value

All figures as of Q1-21, which the company reported last week, on May 5, 2021

$444mm in net debt - Credit facility of  $272mm plus 2^nd lien bonds of $250mm less cash of $19mm and income tax receivable of $59mm

$1,160mm in fully diluted market capitalization - Current share price of $12.50. Fully diluted shares outstanding of 93 million (63mm + 30mm convert dilution)

Let's also assume worst-case cash burn through September 2021 for a total incremental burn of $160mm – six months of cash burn at $27 million per month as per CFO's comments on Q1-21 earnings call.

Bringing this all together, we get a fully loaded enterprise value of ~$1.75 billion.

Therefore, I see Cineplex trading for a fully adjusted ~7.5x EBITDA. If we assume 10x EBITDA as a fair value, then Cineplex is worth ~$18 / share. Again, this gives no credit for non-core asset sales (~35% of market cap) and the outstanding lawsuit (>100% of market cap).

Pre-COVID, Cineplex was one of the highest valued cinema operators given its monopoly like position (75% market share) and in turn, superior financial fundamentals. While the company did de-rate from ~14x EBITDA, the company was trading for ~10x EBITDA on the back of the Cineworld acquisition and was at a similar valuation for most of 2018.

Normalized free cash flow

$230mm in EBITDA after leases (in-line with 2019 figures)
less $37.5mm in interest ($600mm debt outstanding* blended interest rate of 6.25% interest)
less $75mm normalized no-growth capex (capex was $50 million in 2020)
$117.5 million in pre-tax cash earnings
less 25% effective tax rate (no credit for NOLs)
~$90 million in normalized free cash flow

All in all, I see Cineplex as an attractive reopening idea. I see ~50% upside given strong line of sight to a reopening in Canada, coupled with favorable global data points for the cinema industry. I see the potential for additional upside from the sale of non-core assets and a potential legal settlement. This is an actionable idea that trades ~C$7 million per day.

Catalyst

Successful "reopening" of the physical world, non-core asset sales, legal settlement