Description
Overview
Carmike Cinemas has been written up several times on VIC, the last time in December 2005 by baileyb906 when the stock was at $25.33, and prior to that in 2002 after emerging from bankruptcy. I recommend you read some of the older reports for historical details of the company. After a tumultuous 2006, with the company having to restate historical financials, multiple delisting wavers from Nasdaq, a refinancing of its sub-debt with covenant-heavy senior term loans provided by Bear Stearns and new auditors, the company has put its cost structure in order and now presents a compelling FCF story. While the stock recovered after its financial restatements in late 2006, the stock since July has collapsed to levels not seen since the company was in financial distress despite the promise of a strong Q3 and 2007/8. Carmike is now trading at a 2008 FCF yield of 14.5% and 2008 EBITDA multiple of 6.6x, using conservative box office and cost cutting estimates, while also providing investors with a 4% dividend yield. Peers are trading at significant premium to CKEC – RGC, which historically has traded at a 1-1.5x EBITDA premium is now at 9.0x 2008 EBITDA (backing out their stake in NCMI), 2.2x higher and 7.7% FCF yield while Cinemark is trading at a more reasonable 7.7x EBITDA, with a FCF yeild of 8.1% in 2008.
At a FCF yield of 10% in 2008 10%, the stock would be trading at $25.75 or 45% above current levels. Similarly, at a 7.5x 2008 EBITDA multiple, the stock would trade at $24.50 or 38% higher than current levels.
Why the underperformance? CKEC’s recent trading, especially relative to its competitors (CKEC is down 30% since June while RGC is down less than 5%), has been caused by not only investors disappointment with Q2, but with some of the hedge fund trading anomalies as of late, creating a significant opportunity. Much of the recent move from a high of $22.31 on July 17th to a low of $15.83 on August 30th is due to hedge fund liquidations. Sowood Capital, a fund that was down 50% in July and had to liquidate its equity positions had a 410,306 share (3.2%) position as of its latest filing for June 30th. While the company did report relatively disappointing Q2 results on August 7th, the stock was already trading at $17.58.
Why is the outlook bright now? While the optimistic box office estimates for Q1 and Q2 didn’t pan out, Q3 has seen a massive cyclical upswing in box office admissions for the entire industry which should translate to significant estimate upgrades for CKEC for 2007 and 2008. Q1 2007 box office industry receipts were up 7.5%, however this only translated into flat admission revenues for CKEC based upon their different customer demographic (explained later). Attendance was down 7.8%, however, and pricing was up 8.7% compensating for the decrease in attendance. Q2 box office receipts were flat for the industry and also for CKEC, however actual attendance was again down 8.3% for CKEC, but admission pricing up 8.8%. So YTD, its been a relatively disappointing Revenue story – however EBITDA has been increasing at accelerating rates due a fall off of restatement expenses experienced in 2006, additional cost cutting of G&A and Theater operating costs and closings of less profitable theaters. Also, FCF is beginning to ramp as capex is reduced while the rollout of its digital theaters is coming to an end.
A few things happened to the company which didn’t allow the earlier stock thesis to play out
a) Digital upgrades of theaters happened significantly quicker at CKEC than the rest of the industry – they have led the industry by upgrading almost all of their theaters (2200 at this point) in this initiative, pushing out significant cash flow generation until 2007/2008
b) A need for financial restatements were announced during Q1 2006 relating to lease accounting of 100 leases entered into between 1985 and 1999 which were not properly classified. After 2 quarters of delinquency in filings with the Nasdaq, the company finally completed its restatements in August 2006 which also brought with it the resignation of PricewaterhouseCoopers as their independent auditors and the hiring of Deloitte & Touche. During this period also, they received several waivers regarding default provisions relating to their senior secured facilities w/ Bear Stearns, increasing their interest rates and ended up drawing down their Delayed term loan to repay the subordinated debentures that were outstanding. The restatements and auditor fees added in excess of $7 million in expenses in 2006, not to mention the increased interest costs. They did however, continue to pay their dividend of $0.70 / yr during this time period.
Description
I will be brief on the company description, as it has been written up several times previously with in-depth descriptions. Carmike Cinemas, Inc. is an operator of 2,397 motion picture screens in 279 theaters in 37 states, located mainly in smaller cities. Unlike its larger movie theater counterparts, in roughly 75% of the markets they have theaters, they are the only movie venue in town. More than 80 percent of its theaters are found in cities with populations fewer than 100,000.
Because of the locations of the theaters Carmike owns, it clearly has different characteristics and demographics than Regal, Cinemark or AMC.
- Theaters are located mostly in urban or suburban locations in the south and Midwest
- Average theater size is 8.6 screens vs. larger competitors that have 10-12
- 41% of hourly employees work on the federal minimum wage
- Concession gross margins are higher than competitors ~90% vs. Regal @ 85% because of lower employee costs and a higher mix of high margin products (Coke & Popcorn)
- Average Ticket price is $5.84 vs. $7.42 for Regal
- US box office trends and statistics of individual movies do not directly correlate 1-1 with Carmike theaters; ie: the demographics of Carmike theaters tend to watch more action/adventure, family, ethnic movies while dramas tend to do worse than the national average
Opportunity
· Q3 box office is up 17% QTD, the largest gain in years which is not being reflected in street estimates nor in company valuation. With a dismal Q1 and Q2 for Carmike, several blockbuster films during the summer including The Bourne Ultimatum, Harry Potter, Ratatouille, Rush Hour 3, Transformers, The Simpsons should all play well in Carmike’s markets reversing a cyclical downturn at the box office.
· Restatements, and the costs that came with them are over as well as the company has clearly been focusing on eliminating excess G&A costs, and removing costs from Theater Operating expense line – In Q2, this was at 37.4% of revenues vs. 39.1% a year ago. Additionally, the company has been closing down smaller, less profitable theaters. On the FCF side, capex which had been high as the company was building out its digital theaters, will begin ramping down as this is completed at the end of the year, leading to accelerating FCF generation
· Trading opportunity due to Sowood liquidation mentioned above
· Digital Rollout
o Carmike has rolled out digital projectors in almost all of its theaters, significantly ahead of the rest of the industry - 2000 theaters (out of a year end goal of 2200). While the cost side of the equation shouldn’t change dramatically with digital, the revenue opportunities are potentially significant. Digital cinema allows for flexibility in showing movies in various theaters at a moments notice. As an example, CKEC which has an average theater size of 8.6 screens / theater vs. RGC and AMC at 11, can better utilize its screens to meet the demand of consumers. During the opening weekend of Transformers, they can allocate 6 theaters to the movie, as opposed to turning away patrons, and then as demand in the coming days changes, reduce that to 2 or 3 theaters at no additional cost. Additionally, if during the day the theater wants to show more screens of child oriented films ie: Ratatouille, then they can have a screen show that during the day and the same screen show an R rated picture that night. The dynamic nature of the digital format essentially allows for better utilization of CKECs average theater size, maximizing revenue opportunities.
o Carmike has been approaching the digital rollout by upgrading its most profitable theaters first and then rolling downhill. While this has been happening, upwards of 5% of all screens have been non revenue generating at any one time as the upgrades take place. This impact should be more muted as the screens in Q3 and Q4 are the less profitable screens, so again a tailwind to revenues.
o Digital Advertising – Carmike resigned a deal with Screenvision, the leading competitor to National Cinemedia (NCMI) which provides a digital entertainment and advertising based preshow. Screenvision has a network of over 14k screens in all 50 states, and can provide scale and incremental ad revenue for CKEC. Management hasn’t quantified how much they can expect to get from this contract, I have modeled in nothing, however it could be between several hundred thousand to $1 million per quarter in the early stages. All of this is incremental revenue with 100% flow through to FCF. Carmike’s demographics are less optimal to national advertisers, so CPMs will be considerably lower than its larger competitors, however there is value in this relationship, but at this time its hard to quantify given the limited information they have divulged on it and the fact that Screenvision is private. NCMI received $0.56 / theater attendee at its founding member theaters (RGC, AMC & CMK).
o 3D screen rollout in 400 theaters by year end– Carmike has signed a deal w/ Real-D, a provider of 3D technology to rollout 3D technology in 400 of its screens by year end. This technology has been getting significant buzz around the industry, as Regal and others have signed similar deals w/ Real-D and studios are beginning to produce more movies compatible with this format. Carmike will charge a $2-$3 premium over typical movies, with $0.50 going to Real-D to fund the build-out, and the rest split between the studios and Carmike. At this point, there is little inventory of 3D movies, with 3-4 this year into 2008 and 10-12 projected in 2009. James Cameron will be bringing “Avatar” into the 3-D format in 2009 in conjunction w/ Jeffrey Katzenberg who will be bringing “Monsters & Aliens” into the format.
o Live events, games, contests, presentations - Just beginning to explore and rollout the display of live digital events, such as concerts or sporting events. Has signed an agreement w/ the Laugh Factory to roll out in 130 screens in August, which is the first alternative content shown. Also looking into signing deals w/ providers such as NCMI of alternative content and how to structure these deals. Could provide upside probably 2009 onward – again nothing modeled in to estimates.
· Capex peaked last year and will be less than $25 million in 2007, and should fall below $20 million in 2008 as the digital rollout is complete. This combined with a better box office in the back half of this year, FCF/share should begin to accelerate, rising from negative $0.89 last year to a normalized $1.53 in 2007 and $2.51 in 2008.
· Carmike is unique in that they own about 25% of the land under and next to some of their theaters, and in some cases closed theaters. They have been slowly rationalizing this real estate portfolio and they mentioned on the Q2 call that there is still potential and buyer interest for further asset sales. YTD, the company has raised $5.1 million from asset sales and $3.3 million last year. Their debt covenants w/ BS require that cash from asset dispositions go to pay down debt. The company has also stated that the priority for the normalized cash flow is to pay down debt (with no prepayment penalties) and maintain its dividend.
· There is clearly a refinancing opportunity in the future when the credit markets recover, to raise debt at more attractive rates (currently ~ 9%) and to allow for more covenant flexibility.
· Carmike is not a cash tax payer, and has NOLs in excess of $45 mm which should shield taxes through 2010.
· Current dividend is $0.70 / yr or about a 4% yield, with potential to increase as FCF does (company probably wouldn’t buy back shares given the limited float)
· The company has successfully been able to raise concession and admission prices 4-5% / year on average (although this year it was about 8%) and believes it can continue this practice in the future, especially considering the lack of competition in its markets and the admission discount to the larger competitors.
· Finally, with the caveat that the private equity markets are dead right now, there has been a historical appetite from private equity in the film exhibition business, and given Carmike’s cash flow characteristics, it would be an attractive take-out candidate at some point. On the flip side, their last acquisition was in 2005 of GKC at 5.5x EBITDA, clearly a disciplined price; however as bailey mentioned in his write-up a year and a half ago, they do not seem acquisition focused at the time, more so on internal growth opportunities (ie: digital, 3D, advertising, events)
Below is a summary of my estimates and valuation, along w/ comparative valuation of Regal & Cinemark.
| Carmike Cinemas |
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2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
| Revenues |
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| Admissions |
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$ 325.1 |
$ 336.5 |
$ 345.8 |
$ 364.1 |
$ 374.5 |
$ 388.5 |
| Concessions & Other |
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171.3 |
177.3 |
181.1 |
187.8 |
201.4 |
201.9 |
| Total Revenues |
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$ 496.4 |
$ 513.8 |
$ 526.9 |
$ 551.9 |
$ 575.9 |
$ 590.4 |
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| Operating Expenses |
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| Film Rental & Advertising |
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$ 176.8 |
$ 185.7 |
$ 190.9 |
$ 201.0 |
$ 206.7 |
$ 214.5 |
| Concessions & Other |
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17.7 |
18.2 |
18.6 |
18.8 |
20.1 |
20.2 |
| Costs of Operations |
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200.8 |
198.5 |
198.0 |
197.0 |
200.0 |
204.0 |
| G&A |
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29.5 |
22.5 |
22.6 |
23.3 |
23.9 |
24.7 |
| Total Expenses |
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$ 424.8 |
$ 424.9 |
$ 430.0 |
$ 440.0 |
$ 450.7 |
$ 463.3 |
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| EBITDA |
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$ 71.6 |
$ 88.9 |
$ 96.9 |
$ 111.9 |
$ 125.1 |
$ 127.2 |
| Less: Interest Expense |
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$ (47.5) |
$ (45.9) |
$ (43.8) |
$ (38.4) |
$ (33.9) |
$ (28.3) |
| Less: Cap ex |
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(35.4) |
(23.3) |
(19.7) |
(20.3) |
(21.0) |
(21.6) |
| Less: Cash Taxes |
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- |
- |
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(4.4) |
(18.6) |
(21.2) |
| Plus: Asset Disposals |
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3.3 |
5.1 |
- |
- |
- |
- |
| FCF |
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$ (8.1) |
$ 24.8 |
$ 33.3 |
$ 48.8 |
$ 51.6 |
$ 56.0 |
| FCF / Share |
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-$0.89 |
$1.93 |
$2.57 |
$3.76 |
$3.96 |
$4.28 |
| Normalized FCF / Share |
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-$0.89 |
$1.53 |
$2.57 |
$3.76 |
$3.96 |
$4.28 |
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4 |
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| Net Debt / EBITDA |
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4.4x |
3.6x |
2.7x |
1.9x |
1.4x |
| EBITDA / Interest Expense |
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1.9x |
2.2x |
2.9x |
3.7x |
4.5x |
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| Growth (y/y) |
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| Admissions |
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3.5% |
2.8% |
5.3% |
2.9% |
3.7% |
| Concessions & Other |
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3.5% |
2.2% |
3.7% |
7.2% |
0.3% |
| Total Revenues |
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3.5% |
2.5% |
4.8% |
4.3% |
2.5% |
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| EBITDA Margins |
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14.4% |
17.3% |
18.4% |
20.3% |
21.7% |
21.5% |
| FCF as a % of Sales |
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-1.6% |
4.8% |
6.3% |
8.8% |
9.0% |
9.5% |
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| Comparative Multiples |
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Carmike |
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Regal |
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Cinemark |
| Price |
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$17.78 |
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$21.77 |
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$18.32 |
| Market Cap |
$ 228.2 |
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$ 3,589.9 |
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$ 1,965.7 |
| Net Debt |
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412.1 |
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1,540.9 |
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1,305.7 |
| NCMI Stake |
- |
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521.8 |
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323.2 |
| Enterprise Value |
$ 640.3 |
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$ 4,609.0 |
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$ 2,948.2 |
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| 2007 Revenues |
$ 513.8 |
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$ 2,706.1 |
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$ 1,716.1 |
| 2008 Revenues |
526.9 |
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2,700.7 |
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1,791.5 |
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| 2007 EBITDA |
$ 88.9 |
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$ 525.4 |
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$ 369.0 |
| 2008 EBITDA |
96.9 |
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512.3 |
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382.5 |
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| 2007 FCF / Share |
$1.53 |
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$1.73 |
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$0.75 |
| 2007 FCF / Share |
$2.57 |
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$1.67 |
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$1.47 |
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| 2007 EV/EBITDA |
7.2x |
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8.8x |
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8.0x |
| 2008 EV/EBITDA |
6.6x |
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9.0x |
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7.7x |
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| 2007 FCF Yield |
8.6% |
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7.9% |
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4.1% |
| 2008 FCF Yield |
14.5% |
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7.7% |
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8.0% |
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| * Backs out NCMI stake. |
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* Regal & Cinemark estimates based upon Lehman Brothers model
Risks
· Strong box office does not transle well into Carmike markets
· Dilutive acquisition
· Breach of tight covenants under BS debt financing
· Small cap name, illiquidity of position trades average of 162,000 shares / day
· Customer base of Carmike’s is more sensitive to large increases in gas prices
· Recession risk obviously negative for movie theaters
Catalyst
Catalysts
1)Immediate relief on stock due to ending of selling pressure from Sowood Capital
2)Strong box office in Q3 should translate well in CKEC markets combined w/ y/y price increases should boost top line and flow through to FCF, along with falloff of capex, and continued focus on cost cutting at the G&A and Operations level
3)Completion of digital rollout --> company begins to see the benefit of the digital rollout in the revenues, better attendance, increased prices of 3D down the line and additional advertising revenue through Screenvision partnership
4)Uses of FCF as it begins to accelerate --> Pay down of debt will transfer additional value to equity holders. Could potentially increase dividend also.
5)Continued monetization of real estate portfolio to repay debt
6)Debt refinancing eventually - strict covenants; currently debt ~8.71%, capped @ 9.25% but can be refinanced when credit markets return
7)Long term à Sale of the company eventually? - Private equity has shown an appetite for this sector in the past