Description

Thesis summary:

Cineplex is Canada’s top movie theater company, with 69% market share; #2 is Landmark Cinemas (owned by Kinepolis of Belgium since 2017) with 11%.  Cineplex has been very well-run by 66 year-old President & CEO Ellis Jacob for more than 20 years, with CFO Gord Nelson by his side for 16 years.  Shareholders enjoyed a total return CAGR of 14.5% vs. 7.9% for the TSX from IPO on 11/25/03 through 12/31/19 (before the COVID-19 collapse), much of that achieved via cash dividends averaging C$91M (C$1.44 per share) over the past 11 years.  

Please read an impressive interview with Ellis Jacob at this link:  https://medium.com/the-leadership-pad/interview-with-ellis-jacob-of-cineplex-part-1-2-leading-with-values-while-staying-ahead-of-1c921dd0e47b 

At current stock price of C$7.98 (USD 5.88), crushed by the COVID-19 shut-down, a broken take-over deal (buyout by Cineworld PLC (CINE LN) at C$34 per share in cash (10x EBITDA) was announced on 12/16/19, then repudiated (wrongfully, it seems) by the buyer on 6/12/20), and overdone fears of secular decline, Cineplex presents an outstanding risk/reward ratio.  C$300M convertible bond offer (5.75%, converts at C$10.94) closing tomorrow, July 15th, should take the recently raised “going concern” risk off the table, presuming COVID-19 lasts no longer than 1918-1919 Spanish Flu which was over and done in about one year.  

If Covid-19 lingers longer than the Spanish Flu, Cineplex has significant additional capital potentially accessible from various ancillary assets such as their loyalty program, the 10.3M member (27% of Canada’s 37.6M population) SCENE program which has co-branded Visa credit and debit cards with Scotiabank which owns 50% of the JV. 

Cineplex also owns a Dave and Busters type of business in The Rec Room and Playdium which they call location-based entertainment (“LBE”) and grew sales in 2019 at 19% to C$79M with 9 locations.  And Cineplex has the dominant pre-show advertising business in Canada (akin to a National Cinemedia (NCMI) or Screenvision in the U.S.), which combined with a digital sign / out-of-home advertising business (with AMC as a major customer) did C$197M in sales in 2019, +21% that year.  Lastly, they own an amusements rental business (with Regal as a major customer), and have owned real estate like their HQ in Toronto likely worth C$25M.  It is likely that more than C$500M in value resides in these ancillary assets (using 2x sales multiple, in line with peers), just over the stock’s current market cap. of C$505M.  Given an estimated C$15M to C$20M monthly cash burn during recent months at nearly zero revenues, as estimated by management on 6/30/20 conf. call, such potential assets sales could materially extend their liquidity runway if needed.

Fair value estimate = C$22 (+176% from C$7.98 close on 7/13/20).  

Estimated fair value based on 10x EBITDA multiple applied to my estimate of C$250M EBITDAaL (“aL” is “after Lease” expenses) for 2021, a 16.7% margin on C$1.5B in estimated sales.  Assumes C$120M cash burn in second half 2020 (C$20M per month), taking debt from C$664M on 6/30/20 to C$364M on 7/15/20 after C$300M convertible raise closes, to C$484M on 12/31/20, and fully diluted share count increasing from 63.3M now to 92.185M after assuming convertible bonds convert at C$10.94.  On a price to FCF basis, C$22 would be 16x my estimate of C$125M in FCF for 2021.

The Canadian movie theater box office has been essentially flat over the past 10 years, with box office receipts at C$1.011B in 2009 growing only to C$1.022B by 2019, 1.1% cumulative growth (U.S. box office grew over 8% in that period).  But Cineplex still managed to grow sales from C$964M to C$1,665M (+73%, 5.6% CAGR) over those same 10 years, with EBITDA growing from C$160M to C$231M (+44%, 3.7% CAGR), and FCF growing from C$135M to C$169M (+25%, 2.3% CAGR).

Source: Cineplex, Bloomberg

So if the Canadian box office is flat for another 10 years again, or even down somewhat, the out-performance Cineplex achieved over the previous decade bodes well for its prospects.

History:

Nov. 26, 2003:  Cineplex IPO priced at C$10.00.  EV of C$585M, 10x EBITDA of C$59M (TTM 6/30/03, 19% EBITDA margin on sales of C$310M). 29% market share.

July 22, 2005:  Cineplex pays C$500M in cash to buy #1 market share in Canada, Famous Players (46% market share), from Viacom, financed mostly by issuance of Cineplex shares for C$16.10 to C$18.75.  Gives combined entity over 70% market share after 34 mandated theater sales to assuage anti-trust concerns.

Mar. 30, 2009: Onex Corp. (ONEX CN) sells most of its remaining 23% stake in Cineplex for C$14.25, about 8x EBITDA, 10x FCF (both 2008), closing out an investment that began in Dec. 1998 with Galaxy Entertainment and then a much larger investment in Loews Cineplex Odeon made in Mar. 2002 when that entity was in bankruptcy, Onex’s equity investment of C$375M in 2002 yielded proceeds of over C$1B by 2009, 75% of which had been realized by 2004, for an outstanding IRR overall.  Cineplex shares continued rising after Onex’s exit at C$14.25 to a peak of C$54.86 on 5/31/17. 

Oct. 24, 2013:  Cineplex pays C$197M to buy 24 theaters on Canada’s Atlantic coast from Empire Theaters Ltd., giving Cineplex nationwide, coast-to-coast scope in Canada for the first time.

Sept. 18, 2017:  Kinepolis (KIN BB) of Belgium acquires Landmark Theaters of Canada, the 2ND largest in Canada with 10% market share, for CAD 123M which was 7x EBITDA of C$17.5M est. for 2017.

Dec. 15, 2019:  Cineplex agrees to cash buyout by Cineworld Plc (CINE LN) for C$34.00 (C$2.8B) roughly 10x EBITDAaL (est. then was for C$280M in 2020), and a 42% premium to the prior day closing price of C$24.

Mar. 17, 2020:  COVID-19, theaters shut down, Cineplex’s stock price bottoms at C$6.30, down 81% from C$33 on 2/28/20.

July 3, 2020:  Cineplex begins lawsuit against Cineworld, seeking C$2.18B (the C$34 per share cash deal) minus the current value of Cineplex’s stock (C$517M).

July 8, 2020:  Cineplex priced C$275M of 5.75% convertible bonds due 9/30/25, C$10.94 conversion price is 37% above C$7.98 last trade on July 13th.  Presuming 15% over-allotment is exercised, total capital raised should be about C$300M net of fees, all of which will be used to pay down revolving credit line from C$664M level on 6/30/20, but with C$200M then available to re-borrow from that revolver if needed (effect is to reduce revolver limit by C$100M as per recent bank lender covenant relief agreement).  Cineplex said on 6/30/20 conference call that cash burn from operations during shut-down has been about C$15M to C$20M per month.  Presuming six more months of cash burn during a slow re-opening process, at C$20M per month, the revolver goes from C$664M on 6/30/20, to C$364M on convert raise, to C$484M by 12/31/20. 

Bottom Line:

Obviously, investing in Cineplex or any movie theater business at this point requires a belief that 1) the COVID-19 virus is vanquished with a vaccine or just burns out on its own in the not too distant future, and 2) that the bear thesis of secular decline due to Netflix, etc., is not accurate.

I think history has shown all prior pandemics to be transitory, not perpetual, so I’m willing to take the risk that COVID-19 might be exceptional in that regard.  And in the case of the 1918-1919 Spanish Flu, which was much more costly in terms of human life, although much less costly in terms of economic impact, life went back to normal pretty quickly by mid-1919.

As for the bear thesis of secular decline, I believe going to the movies remains a culturally ingrained high-value for money form of out-of-home entertainment that is highly differentiated from, and not mutually exclusive with, the experience of watching movies or series on Netflix or other streaming services at home.  

I also think the prospect of content producers reuniting with distributors will prompt M&A activity as the Paramount Decree of 1948 is repealed.    Given Cineplex’s dominance in Canada, it should be an unusually appealing target in that regard.

At 66 years old, and at the helm for more than 20 years, CEO  Ellis Jacob  showed he was willing to retire  by agreeing to the Cineworld buyout at C$34 in December 2019.  I think he’s probably still looking for an exit when the price / timing is right. 

We are long Cineplex Inc. (CGX CN) and may buy or sell additional shares at any time. This is not a recommendation to buy or sell securities. Please conduct your own research and reach your own conclusion.

We do not hold a position with the issuer such as employment, directorship, or consultancy.

Catalyst

Re-opening relief rally when COVID-19 virus subsides.

Sale or financing from any ancillary assets.

Buy-out by content producer post Paramount Decree repeal

Litigation with Cineworld likely settled by Cineworld and Cineplex reinstating takeover once the coast is clear, but at C$22 (my target, 10x EBITDA) versus original deal at C$34 (also 10x EBITDA, before recent dilution from convertible bond issued and net debt increase).