Description

Executive summary:

• NCMI is a post-reorg equity with a dominant market share position in the niche cinema advertising market
• The company enjoys attractive return characteristics and is set to benefit from a continued recovery in US cinema attendance
• Trading at a forward unlevered FCF yield of 15-20%, net cash position, with a revamped BOD and pursuing growth opportunities

National CineMedia Inc. is a holding company with a 100% equity stake in NCM LLC, which operates the largest digital cinema advertising network in the US. Originally formed in 2002 by its founding members AMC, Regal, and Cinemark, NCM had a stable, recurring earnings stream that generated significant amounts of cash prior to the COVID-19 pandemic. A leveraged balance sheet combined with a liquidity crunch thanks to Regal’s parent company Cineworld's ch. 11 filing befell the company, leading to a ch. 11 filing of its own and subsequent restructuring in 2023. The emergent entity has a net cash position, a revamped Board of Directors, and stands to benefit from a recovery in cinema attendance over the coming years. NCM enjoys a dominant market share position (management estimates 60% of total cinema screens) that requires very little CAPEX (historically around 3% of revenues), and will generate substantial returns on capital for years to come. It has contracts with expiration dates ranging from 10 to 18 years that grant it exclusive rights to sell advertisements on over 18,000 cinema screens across the US. Cinema advertising is highly sought after due to the industry-leading viewer engagement and attractive demographics. These contracts serve as high barriers to entry which diminishes NCM’s competition. At a 20% forward unlevered free cash flow yield, the shares offer incredible value at their current levels.

NCM LLC was formed as a JV between AMC, Regal, and Cinemark (the “Founding Members”) in 2002. NCMI was formed and went public in February 2007, using the proceeds to purchase membership units in NCM LLC from the Founding Members.

Prior to the COVID-19 pandemic, NCM had a very stable, profitable, and cash-generative operation:

Through exclusive contracts with founding members and 42 additional network affiliates, NCM sells cinema advertising to national, regional, and local businesses on both the up front and scatter markets. The company also enjoys a revenue share on beverage sales. Its flagship Noovie program runs content and advertising for 30 minutes prior to showtime; NCM also sells other pre and post-show ads, and ancillary advertising in theater lobbies and digital ads online and out-of-home. HIstorically, NCM generated around 60-65c per attendee in total revenues. In 2019, NCM’s screens averaged 85 attendees per day. As part of the exclusive arrangements, NCM pays fees to the theater exhibitors (“Theater Access Fees”). Net of these fees, overhead and other operating costs, the company consistently generated around $200m in OIBDA (“Operating Income Before Depreciation and Amortization”) and $100-$150m of free cash flow.

When the pandemic struck, the company’s revenues dropped to basically $0, leading the company to drastically cut costs and borrow additional funds to enhance its liquidity. However, when Regal filed ch. 11 in late 2022, it withheld payments and used the opportunity to renegotiate its contract with NCM. This, combined with the slower-than-expected recovery in cinema attendance, caused a liquidity crunch at NCM, who had to subsequently restructure.

NCM management pulled a clever maneuver prior to filing ch. 11. NCMI, (HoldCo), had an ample cash balance that was out of reach of NCM (OpCo) creditors. It used the cash to buy back its secured bonds in the open market. Thus, NCMI became a secured creditor to NCM and received its pro-rata stake in the reorganized entity as per the RSA. Further, Regal surrendered its NCM stake for $0 as part of its contract renegotiations. These actions enabled NCMI shareholders to emerge with a 13.8% ownership in the reorganized entity. Not only that, but NCM unitholders (i.e. former secured creditors) fully exchanged their stake in NCM for newly-issued shares of NCMI. The result is NCMI now owns 100% of NCM. See the below from an investor presentation published last August:

NCM released financial projections in cleansing materials from almost a year ago (note the expected recovery in total attendance):

The figures from 2019 exactly match its stated adjusted OIBDA, so we can assume the 2023/2024/2025 figures represent the company’s best estimate of adjusted OIBDA at that time. Further, in the aforementioned investor presentation from last August, the company highlighted an additional $8m in cost savings that were not previously included in these projections:

Taking these into account, below are revenue, adj. OIBDA, and FCF estimates for 2024/2025:

NCMI also recently announced a new post-emergence equity grant plan. The terms for restricted stock unit awards are clearly laid out as per the below. These targets struck me as aggressive: the stock needs to achieve $8.75 of “Total Shareholder Value” (i.e. market price + dividends) by the end of 2026 in order for grantees to receive 50% of the RSU award, 2.2x the current market price. In order to receive the full tranche, they have to achieve at least $12.75 TSV or 3.2x the current price:

Additionally, for 2025 and 2026, the company must achieve at least 60c/sh and 75c/sh respectively in order to receive the minimum tranche of RSUs, or 15%-20% unlevered FCF yield at today’s price. And that is the bare minimum; in order to receive 100% of the RSUs, NCMI needs to generate $1.00 and $1.20 FCF/sh in 2025 and 2026, a 25-30% unlevered FCF yield. While ambitious, it wouldn’t make sense to set those goals unless the company had a reasonable chance of hitting them. And based on the aforementioned projections,they seem well within reach.

I would be remiss if I didn’t mention the revamped BOD. Biographies are below:

The company also announced yesterday a new push into programmatic advertising as part of the upfront 2024/2025 offerings (I wrote most of this before the announcement, but thought it was worth mentioning).

With a revamped board, a renewed focus on growth, a recovery underway in cinema attendance, and unencumbered by a leveraged balance sheet (the company emerged with a net cash position), NCMI is primed to generate significant FCF over the next several years.

The biggest risks to this investment are a continued secular decline in cinema attendance and capital allocation. Given the net cash position and mid-high teens FCF yield, I believe the current price offers sufficient margin of safety for the former. On the latter, NCMI needs to pursue a healthy balance between high-return growth opportunities and returning capital to shareholders via repurchases and/or dividends (hopefully more the former).

Additionally, the first half of this year is likely to be soft earnings-wise due to last year’s Hollywood strike, but that is behind us and we should expect to see a pickup in 2H24 into 2025.

There is also share price/market technicals risk should NCMI’s new shareholders dump the shares because owning equities isn’t part of their mandate. However, unlike most post-reorg equities, NCMI is actually a good business. Normally curmudgeon credit investors I’ve spoken with don’t appear to be in a rush to exit. Apparently NCMI’s management agrees - hence the aggressive TSV targets on the option grants.

NCMI reports earnings on Monday, March 18. Following its ch. 11, the company reported a $357m gain on deconsolidation as per US GAAP, making a mess out of the P&L. In the coming quarters, the market will be able to better guage the go-forward earnings power of the emergent entity, which I believe will be favorably received. 

Catalyst

Continued recovery in US cinema