Description

Carmike Cinemas (CKECQ) -- $2.50

Based in Columbus, Georgia, Carmike Cinemas is one of the largest motion picture exhibitors in the United States, with 327 theatres in 35 states. Carmike’s theaters are located primarily in small to mid-sized communities. Along with the other major theatrical exhibitors, Carmike overexpanded in the late 1990s, levered the company, and ultimately cannibalized their existing theaters. As a result, Carmike entered bankruptcy in August 2000 and has been operating under bankruptcy court protection since then. In the process, Carmike has shuttered approximately 1/3 of its theatres and has rationalized operations.

On November 11, 2001, Goldman Sachs (through their ownership of preferred stock), Leucadia and Jordan & Company (through their ownership of senior sub debt), and management (substantial equity holders) submitted a reorganization plan to the Bankruptcy Court. The plan is to be approved by creditors and shareholders by December 20, 2001 and to be confirmed by the Bankruptcy Court on January 3, 2002. If these events occur as planned, Carmike will emerge from bankruptcy on January 15, 2002, and will immediately begin trading as a listed equity. Objections to the plan are due December 14, 2001, although it appears now that Carmike has the support necessary from secured and unsecured creditors to have the plan passed. As it stands now, the new publicly traded Carmike will have a total of $420 million in debt and will be owned by Goldman Sachs (39.9%), Leucadia/Jordan & Company (28.1%), existing common shareholders (22%) and Management (10%). Post bankruptcy, Carmike will have 10 million shares outstanding. A limited number of Carmike’s existing common shares currently trade on the NASDAQ bulletin board under the ticker symbol CKECQ. The stock has traded recently between $2.25 and $2.75 per share. The equity had traded at between $0.30 and $0.40 since entering bankruptcy until October 1, 2002, when Carmike filed its reorganization plan – at that point, the stock spiked to above $1.00 and has climbed rapidly since, reflecting significant interest in the reorganization plan. At a price of $2.50 (11.4mm shares outstanding of the old Carmike equity – this is what currently trades), the value of Carmike’s existing equity is $28.5 million. Since the existing common equity will receive 2.2 million shares of new Carmike common equity (22% of 10 million), the implied value of the new equity is approximately $130 million.

According to Carmike’s SEC filings, Carmike will generate approximately $80 million in EBITDA in 2001. This is not a growth story, but Carmike should be able to grow its EBITDA at least 10% annually during the next few years as it benefits from industry consolidation and rationalization (Phil Anschutz -- Lowes, Regal, Edwards and United Artists; and Apollo -- AMC and General Cinemas), as well as its own increased operating efficiencies. While Carmike’s bankruptcy documents project only nominal revenue and EBITDA growth from 2001-2004, we believe, based on conversations with industry executives and insiders, that the company could easily generate $90 million in 2002E EBITDA with no revenue growth. As usual, the bankruptcy document, we believe, tends to understate the company’s true cash flow prospects, as it is clearly not in the best interests of those submitting this plan to be aggressive (in any event, the senior debt currently trades at par and the senior sub debt at $0.95, which provides a clue as to the viability of the company coming out of bankruptcy). Based on $90 million in EBITDA in 2002, the current equity of Carmike is valued 6x 2002E EBITDA. However, cap ex will be nominal at approximately $10 million going forward and D&A on the books is approximately $40 million (most of it is D), which implies significant “excess cash flow” in a state of moderate growth. Moreover, this is obviously a cash business which has favorable working capital implications. Thus, while the EBITDA multiple itself is appealing, the real appeal of the Carmike story is that they will generate approximately $40-50 million in FCF next year, before the required amortization of $25 million of debt. This is a deleveraging story in a rationalizing industry in which you can buy a stable business at greater than a 10% FCF yield (I believe the bankruptcy numbers are understated).

If Carmike trades at 7x 2002E EBITDA, then Carmike’s equity would be worth approximately $210 million ($21 per share post bankruptcy), which would equate to $4.62 per share for the current equity, or an increase of approximately 85% from current levels. While 7x may seem like an arbitrary number, it is certainly not unreasonable and in all likelihood it is too conservative given the stable nature of the business (particularly given industry rationalization and consolidation), the fact that AMC Entertainment (the only publicly traded comp) currently trades at north of 8x, and the fact that cash investment requirements are nominal. Given that this is unseasoned, I’m certainly willing to apply a discount, but anything below $4.00 (right now) seems a bit absurd. Looking out a year, I find it very hard to come up with an equity value of less than $5 per share (7x 2003 EBITDA of $85 million and the paydown of $40 million in debt). More likely, along with re-listing on the NYSE, a year’s worth of seasoning, an appreciation of the new order in the industry, and the continued development and interest in AMC Entertainment (AEN) as a legitimate equity, investors will begin to apply reasonable multiples to Carmike’s excellent cash flow prospects. My reasonable 12-18 month target is thus $9.00 or approximately 8x 2003 EBITDA of $95 million, with approximately $75 million in debt paydown along the way. And my reasonable downside is essentially somewhere around where we trade now -– that is, a continued recession, no EBITDA growth for two years, no multiple expansion, some debt paydown (even with no growth, they pay off 15% of their debt in 2 years), no interest in the industry, etc. Obviously, projected target prices are incredible sensitive to changes in inputs in this case, but you can create your own matrix based on cash flows, multiples, etc. The story remains the same.

As an interesting aside, Leucadia and Jordan own about ¼ of the $200mm in sub debt and they will be converting a portion or all of their debt (I’m not entirely clear) into new common at $3.00 per share. Goldman as well will be converting their $55mm in preferred in to new common at $3.00 per share. And currently, the common is trading at below these levels. So right now, it appears that we can buy the common at a discount (sometimes, depending on the trading activity, at a significant discount) to where these guys are getting their equity, although I would note that Leucadia and Jordan, for example, have a much lower cost based on having bought the debt in bankruptcy (the sub debt actually traded as low as $0.20 on the dollar).

Catalysts:
Emergence from bankruptcy.
Lowball bankruptcy estimates.
NYSE listing.
Significant deleveraging.
Renewed interest in rationalized industry after horrible late 1990s.

Risks:
Continued macroeconomic weakness (although this company does not need to grow its top line to be a successful investment at less than $3.00 per share).
Leverage.
Hitch in emergence from bankruptcy (for conservative investors, wait until December 14th as a start, and then wait until emergence from bankruptcy or at least approval of the plan of reorganization on January 3rd). For thrill seekers, buy now and call your favorite bankruptcy laywer or insider tomorrow to get the week-to-week scoop. I'm not going to recommend either becasue ti obviously depends on your risk appetite.

Catalyst