Description

Carmike Cinemas is an idea that is not new to VIC (written about in December 2001 by pokey351). However, since the previous write-up, the company has performed admirably (as has the industry), while such performance is not, I believe, accurately reflected in the stock price.

To avoid redundancy, I will refrain from writing a lengthy description of the company and refer you back to pokey's write-up. In summary, Carmike is one of three publicly-traded movie exhibition companies (Regal and AMC Theatres being the other two). After a wave of industry consolidation, Carmike is now the fifth largest theatre chain in the US behind Regal (5700+ screens), AMC (3500+ screens), Cinemark (3000), Loews Cineplex (2700+), CARMIKE (2260). CKEC operates mostly in smaller towns across the Southeast United States.

The industry has gone through significant transfomation. In the late 1990's, virtually the entire industry went on a campaign of building out new theatres and upgrading existing theatres with new amenities (such as stadium seating, etc.). The result was over-capacity and over-extended balance sheets. As a result, a total of 12 operators filed for bankruptcy protection in 1999-2000. Coming out of bankruptcy, capital spending in the industry has slowed dramatically, companies have exited underperforming leases and most exhibitors are now generating significant free cash flow. The industry is very much a cash flow story as opposed to a growth story.

Carmike represents an interesting opportunity relative to Regal and AMC for a number of reasons:

- The company is "out of the spotlight", as most of it's theatres are not in major metropolitan areas such as Regal, AMC, Loews, etc. (It should be noted that their assets are not as high quality as AMC or Regal's)

- It is much more illiquid than AMC and Regal. Regal has a market cap of approx. $2.8 billion and AMC has a market cap of over $700 million. Carmike has a market cap of $160 million and over 65% of the stock is held by Goldman Sachs and Leucadia.

- The company is still very quiet and doesn't speak openly to the investment community. They say the reason for this is that they are currently still finalizing some issues as they come out of bankruptcy. In fact, Q3 was their first conference call to discuss results and they did not take questions from the public on the call.

Valuation:
I believe CKEC will do approximately $90-95 million of EBITDA in 2003. At current stock prices, it trades at approximately 6.2x EV/EBITDA, vs. 7.4x and 6.3x for Regal and AMC, respectively. However, the opportunity is in the company's ability to generate SIGNIFICANT FREE CASH FLOW.

I believe the company can generate between $40-50 million of free cash flow in the next 12 months:
$90-95 million of EBITDA
- $30 million of D&A
- $35-40 million of Interest Expense
- No taxes
= $20-30 million of Net Income (or $2.18-$3.28 share...5.4x-8.1x P/E)

FREE CASH STORY:
$20-30 million of Net Income
+ $30 million of D&A
- $10 million of CapEx (conservative)
= $40-50 million of free cash flow

With an equity value of $162 million, this represents a multiple of 3.2x-4.1x FCF, excluding any additional cost cutting, margin expansion or top line growth (their avg. ticket price is $4.73, so you can argue there's room to raise prices)

For comparison, I believe Regal and AMC are trading at approximately 15x and 12x FCF, respectively.

The company is levered, but should it perform and continue to generate cash, the FCF yield is very attractive.

If the company produces FCF in the $45 million range and uses it to paydown debt, in 2 years, the stock price could be above $30/share without the benefit of any multiple expansion (EV/EBITDA multiple).

Risks:

- A weak box office (theatre companies are definitely at the mercy of Hollywood's production). In the near term, Q4 looks strong (Harry Potter, 8 Mile, Lord of the Rings 2, James Bond, Analyze This sequel, etc.)

- Continued building by competitors in CKEC's markets

- Overhang of Goldman/Leucadia's stock

Catalyst

- Very attractive FCF yield (approx. 25-33%)
- Strong Q4 box office
- Ability to pay down debt, growing equity value
- Continued consolidation in the industry (I don't believe they will be bought though)