Cineworld Short Pitch

 

Preface

 

We believe shorting Cineworld today offers exposure to an exceedingly rare combination of 1) a long-term fundamental view suggesting the company is trading at a significant premium to conservatively measured intrinsic value and 2) Q1 reported data from three publicly traded companies (which requires some piecing together and isn’t broadly appreciated, but isn’t overly complex) that suggests an extremely high probability that a major component of our thesis will imminently (Trading Update due this Wednesday) become more widely understood, collapsing the valuation dislocation we see.

 

Crucially, our thesis is largely driven by what we see as idiosyncratic and company-specific factors, and is not solely predicated on a directional view regarding the future prospects of the exhibition industry as a whole.

 

Thesis Summary

 

We believe the following summarizes the precarious position of CINE’s equity. End Market Revenue Headwinds (Cyclical and Secular) + Market Share Losses (Secular) + Cost Inflation (Secular Labor + Secular Supplier) à Top Line Declines + Operating Deleverage à EBITDA Declines à Unlevered Valuation Rerating + Financial Leverage à 40%+ Levered Equity Decline.

 

Importantly, we believe that the vast majority of the operating trends noted below have already been showing up in the numbers, but have yet to become broadly apparent due to M&A and other accounting complexities, and thus have been improperly modeled going forward by analysts. In effect we are not predicting so much as observing – drawing logical conclusions from a growing number of data points that we believe analysts have overlooked. Consensus estimates are expecting a 3%+ topline CAGR + margin expansion, whereas we see significant evidence that the company will experience negative topline growth and margin contraction. In addition, we think upside to the security is limited given the current multiple and sentiment.

 

Key points of the thesis:

 

1.       The promised synergies and other benefits from Cineworld’s acquisition of Regal will fail to materialize:

 

a.       The “synergies” articulated by management are, for the most part, not actually synergies, but simply management saying they will run Regal better than their predecessors; we are skeptical for a number of reasons

 

b.       The lack of financial benefits is already being borne out in the numbers, but has been over-looked by analysts (due to complications arising from M&A accounting, semi-annual reporting by CINE, and the strength of the box office in 2018); as a result, margin expansion has been improperly modeled going forward

 

2.       Regal has been and will continue to lose box office market share for structural reasons that we believe analysts have either over-looked or mis-diagnosed

 

a.       Regal has been consistently losing box office market share, and appears to currently be doing so at an accelerating rate, a fact that has seemingly gone unnoticed by analysts and therefore is also improperly modeled going forward

 

b.       We believe this share shift is primarily the result of a prolonged period of dramatic under-investment vs. peers (60% less capex per screen investment vs. AMC from 2013-18); there is no quick/easy solution to rectify this significant hidden liability at the heart of share losses, least of all “management special sauce”

 

3.       Disguised price competition is being introduced by key competitors that may exacerbate market share losses for Regal

 

a.       The theater industry has grown for a number of years by offsetting volume (i.e. audience) declines with price (i.e. ticket price) increases

 

b.       Key competitors AMC and CNK have started cutting prices in a veiled manner by introducing subscription programs and increasing promotional intensity ($5 Tuesdays just one example)

 

c.       In its most benign form, this will lead to increased share shifts from CINE, in a more draconian outcome, industry-wide price competition accelerates, causing pain for all operators (on levered balance sheets); CINE LN loses in either scenario

 

4.       Wage inflation increases are structural and are likely to cause meaningful operating deleverage

 

a.       Theater operators (including Regal) have significant exposure to minimum wage labor in states that have recent and/or pending minimum wage increases

 

b.       This has already begun to show up in results from competitors AMC and CNK, yet is being overlooked and improperly modeled going forward at Cineworld

 

c.       We believe this inflating portion of a largely fixed cost base is highly problematic in the context of revenue headwinds at Regal; we believe street expectations for ~100bps of consolidated margin expansion in 2019 are grossly unrealistic

 

5.       We believe there is downside risk to 2020 box office estimates:

 

a.       2018 was (and 2019 is likely to be) a historically strong box office year for clear and identifiable reasons:

 

                                                               i.      MoviePass effectively subsidized the industry, prior to fading away as its business model issues became apparent (2018)

 

                                                             ii.      Disney, which dominates the box office, had a historically strong slate as it rushed to strengthen its movie slate and franchises in advance of Disney+’s launch (2019)

 

b.       However, over any meaningful period of time, box office growth has demonstrated a very strong pattern of mean regression; given we are currently in a period of outperformance we believe a correction is inevitable

 

                                                               i.      The 2020 film slate is lacking in several key tentpole franchise releases, and we believe is shaping up for a potential over-shoot to the downside (also not atypical)

 

6.       The industry has developed an unhealthy reliance on a single studio (Disney) to sustain performance, which is likely to have negative long-term economic consequences

 

 

 

How do we get paid?

 

1.       We believe market share losses should begin to become more apparent this Wednesday (May 15) when CINE provides their first trading update of 2019

 

a.       1Q19 data points suggest AMC and CNK have continued to steal share YTD

 

b.       We expect Cineworld to report YTD US box office revenue growth that lags the market’s -8%, causing Regal’s persistent market share losses in the US to become widely evident for the first time since the Cineworld acquisition

 

2.       Many of the underlying business trends become increasingly clear over the next ~12 months as CINE laps the Regal acquisition

 

a.       Market share shifts

 

b.       Cost headwinds will become clear as margin comparisons become cleaner

 

3.       “Synergies” ultimately fail to show up in the financials

 

a.       We expect they will claim realization of these synergies (we don’t recall EVER seeing a management team admitting to missing a synergy target, we suspect because what gets put into the “synergy” bucket is fungible)

 

b.       However, we believe they will never show-up in actual performance. The implication being either: a) the synergies weren’t there or b) the base business fell off a cliff. We view the difference as largely semantic (i.e. what do they choose to call a “synergy”)

 

4.       We think revenue will miss, EBITDA will miss by more, and management may be forced to increase capex investment in a bid to stem market share losses, putting significant pressure on FCF

 

5.       Investors (in an industry that seems to focus myopically on the near-term) will begin to focus on 2020 at some point in the next 3 – 6 months; we don’t think they will like what they see

 

 

 

Background

 

Regal: To properly understand Cineworld today, it is important to have at least a cursory understanding of the history of their principle asset, Regal Entertainment. Controlled by Phil Anschutz, who combined the Regal, United Artists and Edwards circuits out of bankruptcy in the early 2000s, Regal was seemingly run for cash for much of its history, experiencing consistent declines in average attendance per screen, but relatively stable EBITDA per screen, driven by rising ticket prices, better food and beverage attach rates and tight cost control.

 

Importantly, while Regal’s EBITDA per screen was consistently 20-25% below CNK and AMC (pre-CKEC), this disparity was entirely due to lower attendance levels. On an EBITDA per admit basis, RGC actually led the industry, generating an average of $2.73 of EBITDA per admit from 2012-16 vs. $2.67 for CNK and $2.49 for AMC. This is especially impressive considering the business model has significant fixed operating costs which RGC shouldn’t have been able to leverage as effectively as peers given lower attendance levels, and wouldn’t suggest an obvious cost cutting opportunity at Regal.

 

From 2012-15 the company paid out more than 50% of its operating cash flow as a dividend, with the rest going to capex, which was kept near maintenance levels (3-4% of revenue) until 2014 when the industry’s recliner capex cycle began, and Regal was ultimately forced to respond to aggressive investment from both AMC and CNK.

 

Around this time, Anschutz appears to have become increasingly concerned with Regal’s future prospects, and the business was put up for sale in late 2014, with Morgan Stanley running a process. The company failed to attract a bid, however, with feedback from potential buyers (as disclosed in the Cineworld / RGC merger proxy) that RGC appeared to be relatively fully valued, and that there appeared to be little scope for operational improvements at the company (see discussion beginning on p. 20 here). We think this is relevant context to Cineworld’s subsequent bid. After the process failed, Anschutz partially monetized his stake, selling a total of 26m shares at ~$22 / share via two underwritten offerings in 2016.

 

We suspect that Anschutz / Regal may have recognized the value destructive implications of the aggressive “growth” capex being deployed by its key competitors AMC and CNK. While operators have unanimously touted highly attractive cash on cash returns associated with these deployments, it is tough to discern any benefit to attendance, EBITDA per screen or EBITDA per admit associated with the significant capex incurred by these projects. Further, while most operators talk about “payback” in EBITDA terms, focusing solely on EBITDA fails to account for increases in maintenance capex associated with recliner seating, as they have a much shorter life than flip-back chairs.

 

Since the recliner re-seat cycle began in earnest in 2013, AMC and CNK have invested $374k and $294k, respectively, in cumulative domestic capex per screen, gross of landlord contributions. Regal has invested just $143k, 62% less than AMC and 51% less than CNK. We believe this to be the key reason that RGC’s organic box office revenue and attendance growth have underperformed industry growth rates in each of the last 4 years. Fortunately for Anschutz and Regal shareholders, the Greidinger brothers and Cineworld materialized out of nowhere in late 2017 with an unsolicited cash offer for the company, ultimately agreeing to a transaction which valued Regal’s equity at $23 / share, equivalent to ~9.5x trailing EBITDA and 24x Unlevered FCF.

 

Cineworld: Prior to the Regal acquisition, Cineworld’s theater footprint was roughly split between the UK and Eastern Europe/Israel. ~28% of the shares are held by “Global City Holdings” – the vehicle of the Greidinger Brothers, Mooky and Israel, who are the CEO and “Deputy CEO” of the company. The Greidingers began with a small family business in Israel, before expanding into Eastern Europe and ultimately the UK via a reverse merger with Cineworld. They are generally well regarded as operators given the success of their entrance into the UK; however we believe this “success” was more driven by fortunate timing rather than any strategic or operational choices by the Greidingers, as the UK box office experienced a 17% growth year in 2015, just after the Greidingers’ entrance in 2014. More recently, their position in the UK has come under pressure. Privately held Vue has introduced an aggressive pricing program which has driven significant attendance gains at Cineworld’s (and other’s) expense.  

 

While we have no specific evidence that rising competitive intensity in the UK informed the Greidingers’ decision to make an all-cash bid for Regal at a 40% premium, the transaction did conveniently reduce the company’s UK exposure from ~50% of EBITDA to ~15% just as their business there rolled over (as shown below). Seems like a fortunate coincidence at the very least…

 

 

 

Finally, it is worth noting the aggressive manner in which Cineworld financed the Regal takeover. Given Regal’s EV was >2x Cineworld’s at the time of the deal, and the bid was all-cash, Cineworld had to take on significant leverage, and issue equity equivalent to ~100% of its pre-deal market cap at a 30%+ discount to the prevailing pre-deal share price (essentially forcing prior investors to participate or be significantly diluted). As our thesis plays out, we believe the company’s $4bn debt burden will become an increasing point of concern.

 

Short thesis

 

1) The promised cost synergies touted by Cineworld management will fail to materialize

 

At the time of the Regal acquisition Cineworld outlined $100m of expected synergies (against $600m of 2017 EBITDA as reported by Regal), split $60m / $40m between cost and revenues. While management has claimed to have had success in achieving these synergies (they were awarded full incentive comp based on synergy achievement and subsequently raised the targeted total synergy amount to $150m) we are 1) skeptical of the nature of the “synergies” claimed and 2) see little evidence of synergy attainment in the company’s reported results in 2018. 

 

We view “synergies,” properly defined, as operational improvements which could not be obtained but for combining two companies. In this context, the only real “synergy” associated with the Regal / Cineworld transaction was the opportunity to eliminate Regal’s executive team (which Cineworld has quantified as a ~$20m / year savings). Outside of this, Cineworld’s claimed synergy opportunity mostly amounts to Cineworld management claiming they will run the business more efficiently than prior management, despite the fact that they 1) have no experience operating in the US and 2) Regal’s former management team were well respected in the industry, and the business has a reputation as having been well-run.

 

Accounting changes in 2018, the inclusion of certain JV income in “Adj. EBITDA” (NCM & DCIP), somewhat opaque financial reporting from Cineworld (very little expense disclosure relative to CNK & AMC) and the significant box office growth in 2018 vs. 2017 have all made it somewhat difficult to assess the achievement of synergies at Cineworld. While Cineworld expanded reported US-segment Adj. EBITDA margins by ~100bps in 2018, this is roughly in-line with what analysts should expect in a +9% topline year, and is slightly below AMC’s ~110bps of US EBITDA margin expansion in 2018. We also believe that the company’s increased stake in NCM may have created a 20-30bps tailwind to EBITDA margins (due to increased affiliate income recognized within Adj. EBITDA) suggesting underlying margin performance was worse than the headline amount, and offering little evidence of merger-related margin outperformance.

 

 

 

Further supporting our skepticism regarding the cost savings opportunity at Regal is the company’s previously discussed history of best-in-class EBITDA per admit performance. While Regal has lagged the industry in EBITDA generation per screen, this is entirely due to lower attendance per screen, and not the company’s ability to convert attendance into EBITDA. This suggests the theoretical opportunity to improve EBITDA per screen at Regal would be by driving attendance gains, and not by cutting costs.

 

2) Regal has been consistently losing box office market share due to years of underinvestment, a trend which is unlikely to offer an “easy fix”

 

As previously discussed, and despite public commentary by Regal executives, we believe Regal’s prior owners were skeptical of the implications of the recliner investment cycle for the industry, and as such only deployed recliner capex where they were forced into a local competitive response. This assertion is supported by the dramatically lower amounts of capex invested per screen by Regal vs. peers since the start of the recliner investment cycle in 2013:

 

 

 

As outlined below, Regal has consistently underperformed peers since this investment cycle began, which we believe is primarily driven by underinvestment in the circuit.

 

 

 

Moreover, we would note that despite being seemingly obvious, the rate of market share losses at Regal appears to be broadly underappreciated by sell-side analysts. We think this is partly because of the shift in coverage that occurred at Regal after it was acquired by Cineworld (US analysts -> UK analysts), partly due to the promotional nature of CINE LN management, and partly due to distortions caused by M&A. Specifically, Regal’s reported topline growth benefited in the first half of 2018 from the inclusion of the Santikos and Warren theaters, which were acquired by Regal in 2Q17, before its acquisition by Cineworld. Importantly, Cineworld did not adjust for these acquisitions in its “pro forma” numbers, and has failed to highlight it to investors (to our knowledge). Thus, Cineworld appeared to materially outperform the box office in 1H18 on an as-reported basis. Finally, as many analysts seem to be modeling the business only on an annual basis (per Bloomberg there is just one set of 1H19 estimates), the dramatic slowdown in 2H18 also seems broadly underappreciated. Given CNK and AMC have already reported 1Q19 attendance and box office performance that was better than the market as a whole, these trends have almost certainly continued into 2019, as we will discuss further below.

 

We believe that if Cineworld wants to stem these market share losses (which is necessary to meet investor growth expectations), management will have to significantly ramp up investment levels. Cumulatively, Regal’s underinvestment amounts to an implicit liability of $1.1-$1.7bn (depending on whether the comparison is made to CNK or AMC), significant in the context of a ~$5.5bn market cap. Importantly, given growth expectations from analysts (and presumably investors) this leaves Cineworld management in an unenviable position, with an implicit choice between investing in value-destructive growth capex in a bid to meet street growth expectations, or preserving cash flow while continuing to cede market share.

 

So far, Cineworld management has signaled little appetite to ramp up investment. In 2018 they ran Regal at maintenance capex levels (3.8% capital intensity), and the refurbishment program they are launching in 2019 appears quite superficial (essentially a front-of-house refresh with no recliner deployment, and only in a small portion of the circuit). As long as Cineworld continues to defer this capex investment, we think the only logical conclusion is to assume that market share losses will sustain.

 

3) Disguised price competition is being introduced by key competitors that may exacerbate market share losses for Regal

 

In the last 12 months both AMC and CNK have introduced subscription offerings which attempt to trade per-film economics for increased frequency. AMC’s A-List allows subscribers to see up to 3 films per week for a $22-$24 monthly fee (depending on geography), and CNK’s $8.95 per month Movie Club program offers a single ticket per month plus a 20% concessions discount.

 

We believe these programs, and A-List in particular, represent implicit price competition – a highly concerning development given the industry’s long history of quasi-collusive price increases.

 

While A-List is a source of significant controversy for AMC’s equity story, it is a definitive negative for Regal. Coincident with AMC’s introduction of A-List in 3Q18, Regal’s relative attendance and box office revenue performance vs the industry degraded significantly, as can be seen in the relative market share performance in 2H18 highlighted above.

 

Further, AMC introduced a $5 Tuesday program in 2018, matching a similar, long-standing promotion from CNK, a further signal of increased industry promotional intensity. While film slate mix can impact pricing comparisons, we think it is notable that over the last three quarters average ticket prices for the industry have shown sustained declines for the first time in recent history:

 

 

 

While Cineworld has yet to report any financial results for 2019, we believe public reports provide us with a high degree of conviction in the underlying results of Cineworld’s US business:

 

1.       Industry attendance in the first quarter declined -14.9% from the prior year (this data is widely available, and has been cited by AMC among others)

 

2.       In its 1Q19 earnings release on 05/06/19, NCMI reported that attendance for its Founding Members’ theaters declined -15.8% year over year

 

a.       As CNK, AMC and Regal were NCMI’s founding members, this disclosure closely tracks the aggregate attendance trends of the “big three”, although it does exclude certain theaters acquired by AMC and CNK

 

b.       The close historical relationship between NCMI’s reporting of attendance growth and the actual results of the Big three is shown below:

 

 

 

3.       On 05/07/19, CNK (~14% market share) reported 1Q19 domestic attendance growth of -13%, outperforming the industry and the NCMI Founders’ growth rate

 

4.       On 05/10/19 AMC (~20% market share) reported 1Q19 domestic attendance growth of -11%

 

The marked outperformance of CNK and AMC suggests a high probability that Cineworld has significantly underperformed, a significant development that does not appear to have been priced into Cineworld’s stock.

 

Excluding CNK and AMC, industry attendance fell -16.4% (150bps worse than the entire industry). Cineworld is ~25% of this pool. Moreover, the growth rate in Founders’ attendance reported by NCMI implies aggregate attendance to AMC, CNK and RGC theaters of 133.2m. If we back out attendance already reported by CNK and AMC, we are left with implied attendance of 39.5m at Regal. This represents a staggering 24% y/y decline versus our estimate of 1Q18 attendance at Regal.

 

Concurrent with its annual meeting, Cineworld is set to release a trading update on Wednesday 05/15/19, which will disclose the company’s topline performance through the second week of May. The YTD box office is currently about 8% lower than 2018, and given the fact pattern outlined above, it is almost certain that Cineworld’s reported organic admissions growth will be much worse than the industry. Given this is essentially the first “clean compare” the company will report (as the Santikos / Warren acquisitions will be fully-lapped) we expect this to be the first time Regal’s market share losses are made plain since its acquisition by Cineworld, which we anticipate will be a material negative catalyst.

 

4) A tight labor market, and broadly increasing minimum wage will cause operating de-leverage

 

Outside of COGs (studio revenue share, advertising costs, F&B costs), the exhibitors’ cost structures are largely fixed, consisting primarily of lease expenses (almost all the public traded theaters’ facilities are financed via long-term leases) and labor. The largely fixed nature of these costs can be seen in AMC and CNK’s Q1 results, which showed non-COGs operating expenses (excluding D&A) growing on a per-screen basis, despite significant revenue declines. One under-appreciated headwind we believe Cineworld will face in 2019 is the expense pressure likely to be incurred by significant minimum wage increases in several key states, and the broader impact of an increasingly tight labor supply in the US. The following commentary from Cinemark’s 1Q19 earnings call provides some relevant context: “the portion [of salaries expense inflation] that we expect will continue are things like the minimum wage hikes and just general wage and benefit inflation. Places like California … their minimum wage increases about 10% this year. So we think we’ll see in general about a 4-5% increase [in salaries expense] just from those wage and benefit inflationary factors over the course of the year”.

 

California and New York are increasing minimum wage by 9% and ~7% respectively, off of already high levels. These states represent ~23% of the Regal circuit. On a blended average basis, we estimate that 2019 minimum wage increases alone (before attributing any impact from general wage inflation) could create a $20m headwind to US segment EBITDA in 2019, equivalent to ~2.5% of 2018 EBITDA and a 40bp margin headwind. We believe that Cineworld is highly likely to experience sustained cost inflation on a per-screen basis, regardless of box office performance, making the 100bps of margin expansion modeled by the street in 2019 seem quite unrealistic.

 

5) We see further downside risk to estimates in 2020 attributable to box office mean reversion

 

In the short-term the box office can be difficult to predict and drive significant fluctuations in investor sentiment towards the theater stocks. With a longer-term view, however, the box office has fluctuated around a linear trendline, which implies a normalized growth rate of ~1.5%.

 

 

 

2018 outperformed this trend by ~2.5% and, while the 2019 box office is currently down about 8% YTD, a strong 2H19 film slate could mean 2019 meets or even slightly exceeds 2018’s performance. 2020, however, looks primed for a mean reversion (and more likely an overshoot to the downside) given the lack of several major Disney tentpole franchise films (no Star Wars, Avengers or a major Pixar Sequel) and given the push out of Avatar 2 into 2021 (this was likely to be the largest film of 2020). While many US-based media analysts have incorporated a box office contraction into their 2020 expectations, the European analysts covering Cineworld have not followed suit, with Bloomberg reflecting an acceleration in forecasted growth from 2.7% in 2019 to 3.3% in 2020.

 

We believe investors will begin to focus on 2020’s lackluster slate over the coming months, bringing into focus the downside risk to numbers.

 

6) Disney’s organic and inorganic consolidation of box office market share is likely to have negative long-term consequences for exhibitor earnings power

 

We won’t dwell on this point, but we are concerned that Disney’s seemingly ever-increasing clout within the industry will have negative long-term consequences for their exhibition partners. Since the return of the Star Wars franchise, Disney has seen a more than 1,000bp increase in its North American box office market share from the low-to-mid teens from 2011-14 to 26% in 2018. In fact, Disney contributed ~97% of total box office growth between 2014 and 2018.

 

In 2019 Morgan Stanley is expecting Legacy Disney’s film slate to generate ~$3.7bn of gross domestic receipts (which hasn’t been updated for the material outperformance of Avengers Endgame), growth of more than 20% over 2018. Fox’s slate is forecast to generate another ~$700m. Disney’s combined ~$4.4bn will likely represent 36-37% of the total domestic box office, an unprecedented level of market share for the industry.

 

Further, we believe Disney’s introduction of Disney+, if successful, will lend the company further negotiating leverage over the exhibitors. While at present Disney+ is being positioned as a complementary distribution channel to the theatrical window, it seems possible that bringing major titles to Disney+ closer to (or concurrent with) the theatrical release, or eliminating the theatrical run altogether, might accelerate subscriber growth for the subscription offering – a product on which Disney has essentially staked the company. While Disney has not offered any public indication that they will do this, they have ZERO incentive to signal their intentions, and as such we don’t see their stated commitment to the theatrical window as an “all-clear” signal. We believe the combination of 1) unprecedented market share and 2) a potential wholly-owned alternative distribution channel lend Disney a heretofore unmatched level of negotiating leverage vs. the exhibitors which is likely to manifest itself over time in the form of 1) rising film splits paid to Disney (i.e. COGS pressure) 2) shrinking windows (likely to pressure attendance) or 3) both.

 

Earnings expectations and valuation

 

The key assumptions driving our base expectations for Cineworld’s earnings are below. Note that we think these are quite conservative (from the perspective of our short case) in multiple respects.

 

1.       Box office performance in-line with long-term historical trend, which implies a correction in 2020 and LSD growth thereafter (excludes any downside impact from recent pricing actions)

 

2.       Continued market share losses by Regal, with the segment underperforming North American attendance per screen growth by 200bps per annum

 

3.       2% growth in ticket prices and 3% concessions per patron growth into perpetuity (which, again, seems conservative in the context of previously discussed pricing actions)

 

4.       Modest increases (10 bps per annum) in film rental costs as a % of box office revenues

 

5.       Just 1% growth in opex per screen in 2019 (giving some implicit credit for “synergies” despite our skepticism) followed by 3% growth per annum thereafter

 

These core assumptions for the US segment, combined with stable results from the international businesses (which we also think might prove conservative) yield a consolidated EBITDA CAGR of -5% from 2018 to 2021 on a pro forma basis, and earnings power of $0.23 / share, as outlined in the mini-model below. Given the leverage profile required to generate this EPS, we think the business will warrant a VERY modest levered multiple should our forecast play out. We assign an EV / EBIT multiple of 11x, which suggests a 180p stock price -43% from current levels. This implies an EV / EBITDA multiple of 7.3x, toward the lower end of Regal’s historical range, and a P/E of 10.3x. We believe this optically cheap P/E multiple is warranted by the company’s levered balance sheet and the significant structural growth and margin headwinds relative to most companies.

 

As discussed previously, we think our expectations could become reflected in the stock price relatively quickly as Regal’s relative performance becomes more widely apparent and investors begin to turn their attention to 2020’s film slate. Finally, despite our concerns about the impact certain industry developments (pricing competition, concentration, slate risk) may have on total North American box office growth, we aren’t underwriting a break-in-trend to the downside, so to the extent this were to happen, it would represent a source of further downside to numbers.

 

 

 

 

 

 

 

Risks:

 

-          Near-term box office outperformance

 

o   As we mentioned previously, sentiment around these stocks has a tendency to overshoot to the up and downside depending on near-term box office trends. Further, the slate for the second half of the year is very strong, and the last major release (Endgame) significantly exceeded the most bullish expectations.

 

o   We believe this risk is mitigated by 1) our creation price 2) the fact that the box office is currently down ~9% YTD, meaning most analysts are now implicitly modeling record breaking remainder of the year to get to the +LSD growth implied by their estimates

 

-          We may be underestimating the ability of Cineworld management to improve operations

 

o   For the reasons highlighted throughout this write-up we are skeptical that there is a substantial margin opportunity at Regal absent significant box office outperformance, however, it is possible we are underestimating the cost-takeout opportunity and/or the potential operational improvements new management will be able to extract