Description

Executive Summary

LONG The Marcus Corporation (NYSE: MCS)

Marcus Corp. is a small/midcap theater and hotel business with fantastic risk-reward with near term 2-3x potential. This is a very asymmetric investment opportunity and we believe you can generate an 30%-50% IRR / >1.5x MOIC over the next 1.5 years given (A) clarity on near-term catalysts from pent-up film slate and retail travel, and (B) downside protection its industry leading >60% real estate ownership, recurring revenue from its property management division, strong balance sheet, liquidity, and margin of safety from price at 7.6x EV/ 2019 EBITDA (4.6x pro forma EBITDA / 5.2x FCF) at 2x leverage.

Marcus presents an attractive risk/reward for the following reasons:

1. Marcus is fundamentally a good standalone business and better business than its peers: the company is in a far stronger position than other players in the industry, given the location of their theaters in suburban locations providing quasi-monopoly attributes such as pricing power, lower OpEx and durable economies of scale. Additionally, Marcus is relatively mature in its capex cycle which positions it well for the upcoming recovery.

2. Downside protection: Given strong liquidity ($228mm), low leverage (2x ’19 EBITDA), low cash burn (~$30mm per quarter in Q2-3), low price (7.6x 2019 adj. EBITDA) and asset coverage (60+% asset ownership vs. peers who are around <10%, with ~160% asset coverage in a Chapter 7 liquidation scenario in a company where asset values such as land and buildings are held at historical cost).

3. Near-term catalysts: Film exhibitors’ earnings are highly variable. In a single year, valuation can differ by 2-3x EBITDA turns depending on the film slate. The pent-up 2021/2022 is a film slate never seen before in 20-30 years, with blockbusters like Avatar 2, Batman, Spiderman, MI7, providing a real near-term earnings catalyst from reopening.

4. Highly attractive valuation: Marcus currently trades at 7.6x 2019 EBITDA / 9.3x FCF (11% FCF yield), while most its more recognizable peers trade >15x EBITDA, notably with AMC at 20.2x (post WSB pump), Reading at 20.3x and Cinemark at 9.3x. In addition, adjusted for the 2019 Saint. Kate hotel remodel and Movie Tavern acquisition, Marcus trades at 4.6x pro forma EBITDA / 5.2x FCF (19% FCF yield), which we think it is incredibly cheap for a good business, and these 2 assets have yet to ramp up. Historically, Marcus has traded in the 9-11x EBITDA range in last 3 years, because it benefits from a blended higher multiple given its hospitality mix, and that it has scaled from a small-cap player to the 4^th largest US exhibitor.

5. Free options: There are multiple obvious value-enhancing levers to pull, such as via a sale-leaseback. In addition, management is disciplined and has a track record of special dividends during periods when it cannot find attractively valued bolt-on targets. Marcus’ size and concentrated ownership makes it a perfect platform target for private equity to roll up smaller theaters at 1-3x EBITDA in a fragmented industry. Following the New York federal court’s termination of the Paramount Decrees (1948 Supreme Court case), horizontal integration between studios and theaters are now legal, introducing a new buyer pool of strategic studio buyers who would pay up for synergies.

Brief Business Background and Situation Update

Business Background

Founded in 1935 and headquartered in Milwaukee, Wisconsin, The Marcus Corporation is a lodging and entertainment company led by the Marcus family (~26% ownership) essentially comprising of 2 businesses:

1. Theater business – 4^th largest theater circuit in US, with 91 theaters through 17 states with 1,110 screens, and one theater with 6 screens in Wisconsin (68% 2019 revenue, 78% EBITDA, 88% EBIT). It has a strong presence in the Upper Midwest, including its home market of Wisconsin and a number of properties in the south suburbs of Chicago.

2. Hotel business – Marcus also owns 8 and manages 10 hotels, resorts and other properties in 8 different states with >5k rooms in 8 states (32% 2019 revenue, 22% EBITDA and 12% EBIT). This business also includes a hospitality management business for third parties. Long-term management contracts include both base management fees and incentive fees.

Marcus has historically been a relatively fast-growing company (2016-2019 revenue CAGR of 12.6%) and a high FCF generative business, with EBITDA margins of >21% and high FCF conversion of >95% from low maintenance capex requirements (3% sales) and negative working capital (-1% sales). In 2019, it recorded $821mm revenue and $155mm adj. EBITDA.

Situation Update

It has been well documented that cinema attendance is down ~90% globally and in the US since the onset of Covid-19. As a result, businesses dependent on human traffic such as Marcus are hit particularly hard and are burning cash every minute. On a group level, revenue in Q2 down a stunning 95%.

· On April 29, 2020, Marcus amended its Term Loan, providing a new $90mm 364-day senior Term Loan.

· In September 18, 2020, Marcus completed a $100mm 5% convertible unsecured senior notes due 2025 with a $11.01, causing shares to plunge >30%.

· However, given conservative management of its business, Marcus is in good shape relative to its peers. Current liquidity is strong at $228mm with cash burn approximately $30mm a quarter ($38mm in Q2, $31mm in Q3). In addition, management continues to spend on growth capex in Q2-3 by remodeling some of its theaters to take advantage of downtime.

· Apart from a $91mm Sept 2021 Term Loan maturity, most of the debt are long dated. The Term Loan maturity was pushed back from April, and we believe that it will continue to be refinanced in a Yellen-low interest rate world or draw on its RCF to pay it off.

· As such, all the debt is trading >100 and therefore not interesting.

Capital Structure

Liquidity

[Note that Marcus has adopted the ASC-842 accounting treatment for leases (IFRS-16 equivalent), but we have adjusted the leases in the EV numbers in here for apples-apples comparison.]

Despite the relatively rosy picture, Marcus share price has not recovered meaningfully since March lows, and it actually declined by 30%+ in September when Marcus issued the 5% convertible. In contrast, AMC shares rallied in July when it announced a bond exchange offer which also added leverage and came with additional debt constraints.

Investment Thesis / Variant View

A. Marcus is a fundamentally good standalone business, and better business than its peers. Consider these factors unique to Marcus:

1. Monopoly-like attributes: Although the theater industry is fragmented from a national perspective, Marcus is better viewed as local monopoly. If you examine Marcus’ theater footprint carefully, you will find that their theaters are generally located in suburban community centers where it is typically the only theater exhibitor for that town, and just about the most interesting entertainment option in the area. In 2019, 42% of theater transactions were from its loyalty program Magic Movie Rewards.

a. Contrast this to its larger Cinemark/AMC peers who are typically located in expensive metropolitan areas with A) much higher rent expense and B) more competitive pressure between theaters and with other out-of-home entertainment options (biggest competition for movies is dining out), and C) a far more transient traffic.

b. In addition, theater operating costs are local in nature – Marcus derives significant economies of scale in the markets it dominates, translating to strong bargaining power with studio supplies, local concession distributors, local marketing for movies, benefiting from operating leverage.

c. Furthermore, we expect the industry to have a decline in locations due to the pandemic as the overleveraged players like AMC file for Chapter 11 in Q1 2021. These factors all bode well for Marcus.

2. >60% asset ownership: Marcus owns a >60% of the underlying real estate which provides real downside protection in a liquidation scenario and a godsend in this pandemic environment by way of lowering cash burn from lower total lease expense and cost of capital and cash interest expense.

a. It provides ~160% equity coverage in a Chapter 7 liquidation scenario, in a company where asset values such as land and buildings are held at historical cost.

b. In normal times, Marcus has greater control over its locations and greater bargaining power with landlords, and less vulnerable to earnings volatility from rental escalators, since it records stable depreciation expenses.

c. Hotel business provides greater downside protection from recurring revenue stemming from management contracts, and upscale hotels in US have been on an upward trend ~8% YoY, implying significant capital gains if Marcus decides to divest its hotel properties.

3. Majority of DreamLounger + DLX Ultra/Super Screen upgrades are completed

a. DreamLounger is an oversized recliner double legroom of traditional seating options. These upgrades have positive ROI, and while they result in loss of 50% of traditional seats in average auditorium, the ROI is higher given increased attendance and higher ticket prices.

b. DreamLoungers are available at 77% of its theater circuit, and Premium Large Format screens at 78% – highest percentages in US industry, yet there are a few years’ worth of conversions and low hanging fruit growth remaining (payback >25% IRR).

c. Marcus actually took the pandemic as opportunity to upgrade its seats to minimize downtime in normal times (and actually spent growth capex (!) during this pandemic).

d. While you could argue that there is less low hanging fruit growth going forward, we actually think the company is well positioned for the recovery given the time spent offline (3-6 months) for theaters undergoing renovation, while rivals like AMC and Cinemark are grappling for survival.

4. Marcus’ unique traits are well reflected in its financials

a. Pricing power and cost pass through: in all its operating history, Marcus has recorded price increases is above inflation rate.

b. Recession proof: in 90-92, 00-02, 08-10, movie attendance and attendant sales increased through volume growth and not price increases - people go to the movies more in a recession!

c. High margin, non-capital-intensive: Theater businesses are run with negative working capital, and maintenance capex is about 3% of sales leading to high FCF conversion. In addition, because of lower lease expense, Marcus has industry leading EBITDA margins at ~22%.

d. In addition, both maintenance and growth capex have consistently been lower than D&A, so historical EBIT is understated. Its steady state business puts up ~$160mm EBITDA. Subtract $ about $15-25mm maint. CAPEX and $14mm interest expense, this leaves us with a cash machine of $100mm annual free cash flow, and it takes just 3 years to pay off its entire debt stack. The total impact of COVID-19 is only ~1.2 years of FCF loss.

e. Because of greater local bargaining power and lower lease expense, Marcus is EBITDA break-even at ~15% occupancy on a per-theater basis vs AMC (~25%). EBITDA margins (~27%) are significantly higher than peers (13-20%).

f. This all translates to sustainable free cash flow, positive FCF throughout its operating history.

1. Management is strong in capital allocation

a. Management has been diligent in deploying an opportunistic PE roll-up strategy of acquiring small theaters <$10mm EBITDA in a very fragmented industry where the smaller players have low bargaining power, but at the same time maintaining discipline through pricing prudence and timing (only 3 acquisitions in past 13 years).

b. In periods when there are no attractively valued targets, management has declared special dividends and buybacks.

c. Capital allocation track record:

i. 2006: at the height of real estate valuations, Marcus sold a lodging asset and declared a $7 special dividend (32% yield on $22 share price at that time) and increased quarterly dividend by 36%.

ii. 2008: buys Douglas Theaters at the nadir of GFC for est. 1-2x EBITDA. All cash, too. Also bought another theater asset in 2010, price undisclosed.

iii. 2012: buys back 7% of common shares outstanding.

iv. 2013: declares special dividend of $1 (~9% yield) and accelerates 2 quarterly cash dividends.

v. Between 2012-2016: repurchased shares for an average of $12.

vi. 2019: buys Movie Tavern for est. 2-3x EBITDA.

vii. Annual cash dividends: increased 12.8% CAGR from 2014-2019.

d. In exuberant times, you could very well have an argument that management could have further enhanced shareholder value by selling its real estate and levering up, but in the pandemic environment, this has 100% been a blessing.

e. CEO Greg Marcus is a real fan of movie and loves the business. Long tenured strong senior management team – Greg joined in 1992 and many other senior management joined in the 80s/90s.

B. Theatrical exhibition is a sustainable businesses model

1. We are very much skeptics on the long-term value proposition of theaters. The bear argument consists of these points, all of which we agree with:

a. The Disney+Fox combination increased supplier leverage over theaters, and the long-term studio share of box office ticket revenue will increase at the expense of theaters – ratio currently at ~60% : 40%.

b. Studio supplier leverage will continue to shorten the 75-day theatrical window (time between theatrical release and move to other platforms), evidenced by the recent AMC-Universal deal which reduces window to 17 days[1].

c. Increasingly, mid and lower budget movies may not be shown through the box office at all (e.g. Disney Lady and the Tramp only distributed via Disney+), increasing supplier power and raising film rent.

d. Near-term competitive pressures from PVOD and piracy make going to movies economically illogical – A Star Wars movie will cost a family of 4 = $40 ticket vs. Disney+, $10 monthly subscription.

e. Very long-term, we believe the theater business model is questionable given the improving economics around VR and AR.

2. We were absolute bears until we considered the recent evidence of the abject failure of movies released during the pandemic.

a. COVID-19 was supposed to accelerate change in customer behavior, and Disney/BuenaVista, as the studio industry behemoth after swallowing Fox, was supposed to dominate 2020 and gain significant market share. Yet, Mulan only grossed $70mm on a $200mm budget on Disney+, and Christopher Nolan’s big budget sci-fi Tenet is projected to lose $50-$100mm on a $200mm budget. Following these dismal results, almost all studios postponed movie releases to 2021/2022 when theaters reopen.

3. This piece of evidence led us to reflect and develop conviction around a short to mid-term case for the economic relevance of theaters, even if their long-term viability is in question.

a. The studios continue to value theaters as an indispensable component of the theatrical release supply chain

i. The reduction in the theatrical window due to the growth of streaming platforms is the crux of the debate today regarding the survival of the theater industry, particularly in light of recent news that Warner will not only simultaneously release Wonder Woman on theater and HBO Max but its entire 2021 slate.[2]

ii. We do not think foregoing theater economics entirely is a profitable option for the studios on a steady-state basis. For instance, Disney/Fox PF 2019 box office was $42bn, but total gross revenue is ~$7bn (1.66x $4.2bn) from downstream revenue contribution (1.5x-1.7x received from theaters due to other downstream revenues).[3] To make up for this $7bn revenue shortfall, Disney would need to sign up an additional 100mm streaming households at ~$70 annual subscription fee out of a total of ~150mm households in the US or ~100mm net that do not currently have Disney+. Basically, Disney would have to sign up every incremental domestic household that doesn’t currently subscribe to Disney. Despite the rosy targets set at Disney Investor Day, what was notable was that Disney did not follow in the footsteps of Warner Bros-HBO’s decision to release all its 17 2021 releases on HBO Max the same day as theaters (note that Warner is still going exclusively theaters in the rest of the world). On the ticket point, from Disney’s perspective, why release a high budget movie to Disney+ to entice the incremental $10 subscription, as opposed to earning $40 x 60% = $24 from the Star Wars movie?

iii. So, what is the deal with Warner? In our opinion, Warner’s loss-making move should be better analyzed as a desperate move to acquire customers for its failed HBO Max experiment, and is not be sustainable. Warner Bros. is looking to generate some return on capital today as opposed to “punting these movies into oblivion”[4] (COO of Warner), and streaming is the only viable option for Warner right now. This view is also supported by Universal-Cinemark’s deal[5], which mandates that movies that open with more than $50mm at the box office will be exclusive to theaters for at least five weekends or 31 days before they can be offered on demand. This shows that Universal recognizes that a more dynamic theatrical window is in their best interests to maximize value.

iv. But the main conclusion in all of this is that large, high-budget blockbuster require movie premieres and box office revenues to recoup invested capital, and hence tentpole releases are likely to continue to be shown through the theatrical window.

v. In addition, theaters have downside protection from the shortening of the theatrical window, as 80-90% of box office take occurs in the first 3 weekends, which is a strong mitigant to this should AMC-Universal’s 17-day deal become the industry standard. In addition, AMC will receive a cut of the Universal PVOD revenue stream for those titles. While this cut is likely lower than what AMC would receive at the box office, the upside to AMC shows that supplier leverage has not been abused and it’s not zero-sum deal for the industry.

vi. Theaters also provide a tangible benefit to studios by way of free advertising for movies when movie trailers are aired on the theater circuit a month before movies are released (normally by NCMI), and its unlikely studios would give up this free ad spend in the short-term.

vii. Studio also favor healthy theaters to improve the experience to help them connect with kids emotionally and become part of their childhood, which is an important part of strengthening movie franchises.

b. Competitive threat to Studios/Disney is not theaters, it’s OTTs like Netflix/Amazon

i. People often forget that the initial Disney strategy was to trade moat for margin by selling its content to OTT, but it quickly realized that they commoditized themselves and cut out the long-term value of their content. The problem for Disney is not to solve for box office (which in 2019 was at record level), but their potential to continue monetizing the post theatrical release for its unlimited benefits, including lower cost of capital from visibility into recurring earnings from subscription revenue.

c. Highly valid consumer use cases:

i. High value for money out-of-home entertainment, whether on family outings or initial dates (before you get to the Netflix and chill stage)

ii. If the job to be done is film consumption, then at-home OTT subscription 100% offers the better bang for buck. However, if the job to be done is out of home entertainment, then we think you can have a case for movie theaters as long as people like to leave home occasionally for entertainment purposes. The analogy between theaters and dying brick-mortar retail is a flawed one, as the difference between theaters and retail is that you have to spend to get the experience vs. say mere browsing around. Just as going out to dinner is not comparable to cooking at home. On the margins, there is competition, and there will be erosion of sales for theaters, but to focus on this substitute is to miss the forest for the trees.

d. Going to movies remains culturally ingrained.

i. Consider the stickiness of the Movie Premiere and red carpet, and theaters are very powerful symbiotic partners of studios, serving as showrooms for luxury goods / cars.

e. Rarely mentioned concession drivers provide a kicker:

i. Theaters make 90% contribution margin on F&B. and 45% GM on ticket sales.

ii. With marginal cost of having another moviegoer is $0, theaters should be willing to take a discount on ticket sales to increase volume of attendance.

iii. Marcus generates an industry leading 42% from concessions, growing as a percentage of total sales (thereby also increasing EBITDA margins).

4. Bottom line: PVOD will continue to cannibalize sales, and relationship between studios but for the medium term, studios are still dependent on theater economics, as theatrical showings monetize way better than OTT.

C. Well managed hotel business provides stability and downside protection

The hotel/hospitality division is relatively small (32% revenue), stable, and the equity markets focus on the theater division, so we won’t dwell too much on it. We will simply note that the following points:

1. Marcus’ high-quality assets (7 wholly owned, 1 majority owned) in lodging division provides a good play for pent-up travel demand. For example, Grand Geneva is near a Ski Hill and golf course, and the Saint Kate experiential hotel is located in a highly drivable-to area.

2. Its portfolio of assets is well managed, evidenced by its high occupancy rates of >75% and increasing ADR and RevPAR supported by F&B division, which represents 33% of division sales.

3. Property management contracts for 10 hotels provide additional stability, for example DoubleTree by Hilton El Paso, Courtyard by Marriott El Paso, Hyatt Regency Schaumburg, IL. In addition, many of these are branded hotels like Hilton and Hyatt, which benefits from brand recognition and scale and are relatively less squeezed by OTAs. Profit-sharing contractual mechanisms in these property management contracts provide additional upside kickers. This is also the reason why lenders are giving Marcus much better credit terms than the likes of AMC or Cinemark, which are pure-play theater businesses.

4. Wholly owned investment entity MCS Capital opportunistically invests in new hotels as sponsor, JV partner or sole investor, and management views the current pandemic + low cap rate environment as creating opportunities

D. Catalyst: Film Slate

The fundamental driver of theater attendance is ultimately the quality and quantity of movie content, and as such, industry revenue can be very lumpy from year to year. The 2021/2022 film slate contains a stunning record number of tentpole releases. Titles include Batman, Spiderman, MI7, Avatar 2. This bodes very well for near-term earnings as the US economy reopens.

US box office is likely to follow international market experience when new film slate is eventually released. For example, when Demon Slayer was released in Japan, it generated over $245mm at the box office, which is the second highest grossing movie ever in the Japanese market. In China, when My People, My Homeland was released, the box office generated $310mm from Oct 2nd to 4th, a 27% YoY increase vs 2019 when there was no pandemic.

(Source: Marcus Investor Presentation)

E. Valuation is artificially depressed by technical reasons

So, given all of this, why has the stock price not rallied alongside AMC, and remain depressed at 4.6x run rate 2019 EBITDA?, despite being a better business?

1. Poor analyst coverage. Marcus is currently only covered by 3 small firms: B. Riley & Co., Barrington Research Associates, and The Benchmark Company, which is absurd given that it has almost a billion-market capitalization in normal times.

2. Low-mid cap: At ~500-600mm market cap range, Marcus does not screen well at the moment.

3. Not a meme stock: Part of the reason is Marcus is not like AMC; AMC has a little of a Robinhood/#wallstreetbets stock dynamic going on, given its brand association with theaters, much like how Hertz rallied 825% since filing for Chapter 11, being strongly associated with reopening bets.

4. Market misunderstands convertible debt raise:

a. Strike price is $11.01 nominally (22.5% from $8.99 issue date), but $17.98 after convertible capped call transactions (100% from issue).

i. In addition, management negotiated to settle these notes at maturity with cash / equity, providing ability to reduce actual dilution at maturity.

b. But this concern is unfounded:

i. Market misunderstands actual dilution of maturity. Management has stated its intention to settle the principal of convertible notes in cash, and only settle ITM portion of notes with stock.

ii. Furthermore, the debt package is attractive. The $87mm in unsecured convertible senior notes at a rate of 5% due in 2025, is a strong play given the extremely low interest rate with a due date that is quite far out from now. Marcus can potentially capitalize on such a rate given their real estate assets. As evidence, all the debt is trading >100 (vs. AMC at depressed levels), which goes to show how absurd the Marcus equity is traded at today.

5. In addition, 2019 EBITDA is lower because:

a. Acquired Movie Tavern (23% screens) closed only in Q3 2020, thus only capturing a couple months of run-rate sales.

b. Marcus closed InterContinental Milwaukee (4% of rooms) in early Jan to remodel the hotel into an experiential arts hotel named Saint Kate, resulting in loss of revenues of ~6months, preopening expenses and start-up costs (total $4.2mm), low-initial ramp up comparing a new independently named hotel to a branded “InterContinental” hotel. This should change as Saint Kate has won a Conde Nast award[1], giving it incredible recognition and searches of ‘top Milwaukee hotels’ show Saint Kate as one of the top 5, which bodes very well for hospitality revenues.

6. Family ownership of 25% offers additional protection as they will never sell now at 6x when they have just bought stock around these levels.

[1] https://www.cntraveler.com/hotels/milwaukee/saint-kate-the-arts-hotel

Valuation and Investment case

Valuation

Marcus has traded meaningfully above its peers in the past 2-3 years due to lower leverage, theater business quality, and stability from its hospitality division (peers trading ~10x).

However, Marcus is currently valued at a lower multiple than its peers…

(Adjusted for leases)

…despite having market leading margins (partly due to its hospitality division)

In the last 3 years, Marcus has been valued at ~8.6x EBITDA.

Investment Case

1. View on recovery and when people return to theaters:

a. Generally, we assume vaccines will be widely available in Q2. By Q3 and Q4 of 2021, we assume things revert to normal.

b. In Q4 of 2020, Marcus will see ~2mm traffic as traffic starts to trickle in for James Bond, Wonder Woman, Death on the Nile and Free Guy. For context, there were only about 350k traffic in Q3, despite only having Tenet as the major movie.

i. Despite this, we assume that cash flow in Q4 of 2020 worsens due to a resurgence of COVID-19 over festive period, and company burns $39mm in Q3 (worse than Q2).

c. Q1 2021 traffic is assumed to remain the same as Q4 despite having Kingsman, James Bond.

i. Despite this, we assume that cash flow in Q1 of 2021 company burns the same as Q3 2020.

d. In Q2-Q3 2021, we assume traffic increases ~15-30% a quarter and things return to normal by Q4.

2. View on steady state – a permanent decline in theater top line: As mentioned, we assume permanent impairment to theater business model and account for industry secular headwinds by modelling lower industry box office revenues. We model a 10% decline in FY2022 sales vs. FY2019 (pro forma for Saint Kate and Movie Tavern), which we take to be market’s assumed steady state earnings power in the medium term.

a. To be even more conservative, 100% of the assumed 10% decline in sales is assumed to be volume. Ticket prices are assumed to remain constant, despite demonstrated pricing power: Marcus has never failed to increase prices by ~3-5% every single year since 2015.

3. View on hotel traffic:

a. We assume that hotel traffic remains slightly depressed in 2021 and only returns to 2019 levels in 2022. We believe this assumption is conservative given A) retail pent-up demand for travel, B) proximity of Marcus hotels to leisure activities like golf and ski, and C) Marcus hotels are generally located in areas where you can drive to, which is a lower barrier to consumption in COVID-19 times.

b. Assumptions for Q4 of 2020 to Q4 of 2021:

i. Occupancy rates increase by 8% per quarter from 37% in Q3 2020 till 74% (2019 average) in Q3-Q4 2021.

ii. ADR decreases as occupancy rates revert to the mean (ADR was very high in Q2 and Q3 of 2020 as presumably people took ‘staycations’ and opted to have meals in their rooms to observe social distancing practices).

iii. F&B revenues track hotel occupancy, despite demonstrated increase in F&B as % of hotel revenues.

4. View on capex: We expect capex of $42mm going forward ($53mm in 2019) as almost all the growth capex (theater upgrades with recliners and screens, concessions upgrades) are complete.

5. Multiple: Historically, Marcus has traded above AMC and Cinemark because of its superior business model and low leverage (2x EBITDA even at today’s capital structure, versus AMC 6x). Accounting for its lodging assets, you are looking at a blended 8.5x-9x multiple.

6. Additional kickers not modelled: We do not model in the upside free options, nor do we account for $21mm anticipated tax refunds (50% of 2019 FCF)

7. Base case return expectations:

a. We expect a steady state $160mm EBITDA by Q1-Q2 2022, accounting for permanent impairment to traffic volumes and despite incredible film slate. At 8-9x EBITDA, you are looking at a return of 60-80% IRR and 2-2.5x MOIC over a 1.5 year hold.

b. Given fundamental attributes of this business and Marcus’ >60% real estate ownership, we believe this investment has asymmetric risk-reward.

Model

Risks / Mitigants and downside case

What are the key risks? In our opinion, there are two, but we also believe there are strong mitigants.

1. The first risk is shorter-term, in the scenario of a delay in vaccine distribution or questions around vaccine efficacy.

a. We do not believe that this risk is material, but we also concede that we are not qualified to have a medically informed judgment.

b. However, we believe that this risk is mitigated by existing debt capacity in debt documents, and Marcus’ ability to use their real estate as leverage or collateral in uptier exchanges for the bonds should the pandemic continue to force closings, and which potentially lessens the burden of high-interest payments on debt moving forward.

c. In addition, the only debt covenant Marcus has is a minimum consolidated liquidity of $125 million. In Q3 2021, Marcus has a minimum EBITDA covenant starting at $0 in EBITDA ($20k in Q4, $35k in Q1 2022, $60k in Q2 2022) which we expect Marcus to be able to comply with as vaccines are distributed, films begin to be released, and traffic returns to theaters.

d. In the worst-case scenario, such as theaters and hotels remaining closed, if the vaccine does not work well, Marcus should lose about $30mm a quarter, giving it more than 1.5 years of liquidity in a zero-revenue situation.

e. In the absolute worst-case scenario, the company liquidates but equity is still well covered.

2. The second risk is longer-term, by way of multiple compression from industry headwind.

a. As mentioned, we are quite pessimistic on long-term prospects of the theater industry, and as such, we model a permanent traffic decline of 10% in 2022 which we assume will the medium-term steady state earnings by which the market values Marcus.

b. The mitigant to multiple compression is that, even if the market continues to discount theater valuation, an earnings recovery would present you with an upside of ~15% IRR and 1.2 MOIC over 1.5 years.

c. In such a situation, we believe that management would begin to focus on asset monetization (remember, asset coverage of 62% which is already a highly discounted figure) and pivoting the Marcus business to focus on its higher-multiple hospitality business.

Risk is mitigated by asset coverage, which provides meaningful recovery and return in a liquidation scenario

Free call options

There are multiple obvious levers for company to pull to create value:

1. Sale and lease back and return the capital to shareholders via buybacks (preferred) or dividends – this will transform the business into asset-light and increase return to shareholders.

a. Even better, the company spins-off real estate into REIT which will optimize tax and enhance returns at Marcus Holdco level.

2. Asset sales: Management has stated their intention to sell non-core assets, which include unused buildings, parking lots, old restaurant locations – these could be sold in the next 1-2 years, for $20-30mm in proceeds.

3. Private equity: Marcus is an attractive PE target because of its recession-proof, FCF generation nature, with modest organic growth that can be accelerated by accretive acquisitions as Marcus has done in the past at

a. Almost every scaled theater player has been through private equity ownership: Onex-Cineplex, Blackstone-Cineworld, Cinven-Odeon, Silver Lake-AMC, Apollo-AMC, OMERS-Vue. At TEV ~$1bn in normal times, Marcus is attractively sized target.

b. Theaters are generally taken out at 8-10x EBITDA (ignoring AMC-Carmike 7x, which was highly controversial). For example, Regal was sold to UK’s Cineworld for 9x, and Odeon was acquired by AMC for above 9x.

c. At 55, CEO Greg Marcus may look for an exit when the price and timing is right.

4. Entry of studios into buyer pool:

a. In Aug 2020, a federal judge gave permission to the DOJ to terminate the 71-year-old Paramount Decrees which essentially restricted major studio control over the exhibition process for anti-trust reasons. This opens pool of potential Marcus acquirers to include strategics such as studios.

b. Given Greg Marcus’ open-mindedness for for JV’s in their hospitality division, it would not surprise us if Disney/Fox or some other major studio invests a minority stake or enters a strategic partnership with Marcus. Usually after a Disney ride you exit right into a Disney store, why can’t it be the same when you leave a Disney movie? Given Marcus’ asset ownership, it is very well positioned to leverage on this trend and has the right to implement capital improvements to its cinemas without going through onerous process of seeking landlord approvals.

5. Operationally, theaters could begin to show episodic content such as Game of Thrones, given that the cost per hour production value of these shows are at parity with big budget films. Movie theaters do not need to be only for movies, just as airlines do not need to be only for air travel (Singapore Airlines sold out an offering to have a meal on its A380 and watch a movie on a grounded plane!)

6. Emphasize hospitality division for higher valuation: Marcus could also divert more investor attention to Hotels business given value attribution today in a low cap rate world, which may contribute more to a higher multiple.

Final thoughts: how to trade theaters

1. Investors in theaters tend to be short-term focused and names in this industry has historically been volatile. The way to trade theaters is to focus on anticipating film slate catalysts – theater equity name frequently outperform on strong theatrical windows (e.g. in Q2 2018 when valuation of theaters spiked due to the blowout box office numbers and excitement around the release of Black Panther and Avengers: Infinity War) and underperform when film slates are weak and when there are terminal value concerns causing derating of multiples (e.g. 2017 PVOD concerns). Given the incredibly strong 2021/2022 film slate, we believe now is the right time to establish a position in Marcus given the attractive valuation.

2. This is not buy and hold long-term compounder, as we think long-term prospects of theater exhibitors may be in question. As such, we recommend exiting the position late 2021/early 2022 when earnings have recovered, and the market discounts the LT threat of studios and media substitutes which we think is likely given intense competition and regular price increases in the OTT industry.

Note: There have been many good theater writeups in the past on AMC, Carmike, etc., by RSJ and others, and I would encourage readers to read those writeups and the comments if of interest.

Catalysts

1. Near-term

a. 2021/2022 Film Slate + Vaccine leading earnings recovery

b. Rebooking for events e.g. Ryder Cup

c. Multiple reversion

d. More analyst coverage

e. Hotel supply growth likely limited in coming years which is favorable for existing hotels

f. Deleveraging

g. Management provides more conservative capex guidance on normalizing

2. M&A

a. Deep value and opportunistic acquisitions in low cap-rate environment (half of industry screens ~20K held among ~800 small operators)

b. Sale of surplus real estate – Management characterized its asset monetization strategy as “Active”, and have several assets under LOI and listed as Available For Sale

3. Operational:

a. Continued increase in concession/F&B spend from ordering ahead of time via app (long lines can discourage concession spend)

b. Continued increase in “alternative programming” such as live sports, concerts, classic movies, art and independent films, and genre-specific films

4. Other:

a. Dividend reinstatement (historical average yield around 2%)

b. Share repurchases – history of share repurchases at around $12

Appendix

Liquidation Schedule

Real Estate Schedule

Dilution schedule

Market share

Domestic Attendance & Box Office

[1] https://variety.com/2020/film/news/amc-universal-deal-entertainment-industry-future-1234718942/

[2] https://variety.com/2020/film/news/amc-warner-bros-hbo-max-1234845908/

[3] Disney 10-K

[4] https://www.wsj.com/articles/warner-bros-to-release-all-2021-films-on-hbo-max-in-theaters-simultaneously-11607020941

[5] https://variety.com/2020/film/news/universal-cinemark-deal-movie-theater-theatrical-window-1234833613/

[6] https://www.cntraveler.com/hotels/milwaukee/saint-kate-the-arts-hotel

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst