Description

RDI’s COVID-impacted market price provides an opportunity to profit on cinema reopening if you don't want to wait for the big payoff: a favorable resolution to a years-long litigation effort.  Omicron’s resolution and an expected new lease at a key real estate asset provide a tailwind in the near term.

Since last written up by UCB1868 in 2017, Reading has upgraded a number of its cinemas to add enhanced food and beverage services and recliner seating, completed the development of a one-of-a-kind NYC office/retail asset, and profitably sold certain other properties to bolster its cash position during the pandemic.  Certain members of the Cotter family continue to intentionally drag out lawsuits related to the potential disposition of the controlling block of Reading’s voting stock (RDIB) owned by a family trust. COVID may have actually helped the argument that the block should be sold to the highest bidder.  Such an auction, if ordered, would result in a home run from current RDI prices.  Regardless of the litigation outcome (and the timeline thereof), we believe the current RDI stock price provides an opportunity to make money on cinema and real estate leasing alone.

We are recommending RDI, not RDIB.  References to “RDI’s stock price” throughout refer to the price of the Class A, non-voting stock whose ticker is: RDI.

Background

Reading operates cinemas in the United States, Australia, and New Zealand, and has historically used the cinema cash flows to invest in real estate assets.  The cinema business operates under the brands: Reading Cinemas, Angelika Film Centers, Consolidated Theaters and State Cinema.  Key owned real estate projects include: 44 Union Square in NYC; Newmarket Village, Cannon Park and The Belmont Common in Australia; Courtenay Central in New Zealand.

The Company provided a detailed business overview/update powerpoint at its December 2021 shareholder meeting which can be found here.

I encourage you to review UCB1868’s write up which provides useful corporate history and background.  In short, the Company was run, and controlled via a separate class of Reading voting stock, by James Cotter, Sr. (referred to herein as “Senior” given the number of Cotters in this saga) until his death on September 23, 2014.  Senior was survived by three children: James Cotter, Jr. (“Junior”), Ellen and Margaret.  Junior has since also passed away (on 3/10/21) leaving sisters Ellen (age 55) and Margaret (53) as Senior’s last surviving children.  However, the next generation, Senior’s five grandchildren, have an indirect role to play as the beneficiaries of the family trust that effectively owns the controlling voting block of the company.  The court has appointed a guardian ad litem to protect the interests of the grandchildren.

At the time of Senior’s death, he owned 1,123,888 shares of RDI Class B voting stock (roughly 67% of the RDIB shares) and 2.27 million of the nonvoting Class A RDI stock. Per the terms of Senior’s will, all of the RDIB shares he controlled, a controlling block, were to be distributed to the “Cotter Voting Trust” ( the “CVT”).  The Trustee of the CVT is Margaret and the beneficiaries are Senior’s five grandchildren (Margaret’s two children and the late Junior’s three children;  Ellen has no children).  Importantly, the shares of RDIB will be the sole asset of the CVT.  The distribution of the shares to the CVT has yet to happen, apparently for legal reasons, as the 12/31/20 10K notes the following:  “At 12-31-20, 67% of Class B Stock is held by the Cotter Estate and the Cotter Living Trust, ultimately for distribution into a voting sub-trust (the “Cotter Voting Trust”) of the Cotter Living Trust.”  [See cap table below based on the 11/15/21 proxy statement]

Litigation commenced after Senior’s death between Margaret and Ellen and their brother Jim relating to the “James J Cotter [Sr.] Living Trust dated August 1, 2000” (Superior Court for the County of Los Angeles - Case number: BP159755).  In connection with this litigation, on 3/1/17 the court appointed Christopher D. Carico as a guardian ad litem, or GAL, to represent the best interest of the minor beneficiaries of the CTV.  

The GAL argues (starting even before COVID) that the CVT’s concentrated holding in the RDIB (voting stock) without any diversification creates a huge unnecessary risk to the beneficiaries’ financial well-being.  RDI’s stock price performance compared to the S&P 500 (as a proxy for a diversified portfolio) over the past two years has made this conclusion seemingly irrefutable.  Even if RDI had outperformed the index, the risk to the financial well-being of the grandchildren would still be unacceptable as they bear 100% of the diversifiable risk of the single stock portfolio.  

RDI versus SP500 2015-2021

As such, the GAL is seeking a court order compelling the CVT’s divestment of the RDIB “in a manner that maximizes the price received for the control premium” with the proceeds invested by the trust (or trusts) in much less concentrated manner.  

The sisters oppose this effort largely because losing control of the voting stock would likely result in the loss of their lucrative employment contracts with Reading, and the status that goes along with controlling a publicly traded company.  Ellen is currently the CEO and President of Reading.  Margaret is Chair of the Board and EVP - Real Estate Management and Development NYC.  Secondarily, a change of control would result in negative Cotter Sr. estate tax impacts.

This multifaceted litigation is ongoing and unfortunately, a resolution does not appear to be imminent.  On 12/14/21, Judge Susan Matcham (Superior Court of CA, County of Los Angeles) stayed several matters before her, including the GAL’s 7/19/19 (yes, 2019!) Ex Parte Application for Authorization to Engage FTI Consulting as his Valuation Expert to Perform an Independent Valuation of Reading, and continued the hearing until June 13, 2022.   Other critical actions also remain pending.

The significance of the GAL’s effort is that we know of at least one interested buyer for the CVT’s controlling stake (and, in fact, the entire company). In 2016 and again in 2019, Patton Vision LLC and a consortium of investors, including Madison Dearborn Partners, and TPG, expressed interest in purchasing Reading for amounts well in excess of the current market cap.  Reading’s board, and Margaret on behalf of the CVT, have refused to consider Patton Vision’s proposals or even negotiate with Patton Vision, much to the chagrin of shareholders not named Ellen or Margaret.

Since Patton Vision’s first offer, and frankly since Senior’s death, the “investment road” has been littered with investors who hoped for a sale of Reading to the highest bidder only to see Margaret and Ellen erect one legal roadblock after another to delay court action, preserving their respective positions with the company.  As but one example, nearly three years after the GAL was appointed, Ellen and Margaret moved the court to disqualify the GAL for an alleged conflict of interest.  The motion was denied, and the then judge, Clifford Klein, made some encouraging comments (to my eye) vis a vis the Trust in his 1/24/20 ruling (forgive some highlighting).  The case has outlasted Judge Klein who retired earlier this year.   

The ponderous pace of the litigation coupled with COVID’s direct hit to the cinema business has driven Reading’s market cap to a valuation that offers investors an entry price that does not require litigation success, or even resolution, to profit.  If you believe that Delta, Omicron and whatever comes next can be managed, RDI’s trading price in 1H 2021, before Delta and Omicron, indicates some of the possible upside from today’s price even with movement on the litigation front progressing at a glacial pace.

Valuation

Following is a conservative valuation analysis.  There are any number of variables that could reasonably be increased resulting in a higher valuation, but we want to show that even under conservative assumptions the discount to even a COVID-adjusted fair market value at today’s prices is significant.

2021 RDI Stock Price History

RDI Stock Price 2021

RDI vs. Cinemark Holdings Stock Prices 2021 for reference to another cinema stock

Sum of the Parts Valuation

Reading’s cinema/theater business is currently losing money due to COVID.  The business, which produced an average of $44mm in annual EBITDA between 2013-2019, experienced an operating loss of $17.5mm for the trailing 12 months ended 9/30/21, which was an improvement from calendar 2020 (Segment EBITDA: ($29.6mm)) .  Likewise, certain of Reading’s owned real estate assets experienced rent collection challenges due to COVID, depressing results in an historically profitable segment.  

Assuming governments and people are positioning themselves to manage in a world with COVID in it, we expect the cinema business and the developed real estate assets to rebound to profitability in the coming years.  When?  It is hard to know.  But Reading’s balance sheet with $90mm in cash, no material debt maturities until 2023 and additional discrete real estate assets that can be monetized gives us comfort that Reading will survive until (more) normal times.  We credit management for getting the company through the last two years without a dilutive financing.

Assuming book value of all real estate assets, a conservative assumption, and a haircut on the cinema business, a sum of the parts results in the following:

We value Cinema/Theater business as follows, with cash carrying cost reflecting estimated continued Cinema operating losses as COVID winds down/gets managed over the next two years:

For context on the real estate SOTP valuation, here is a more detailed estimated valuation of the recently completed, and as yet un-leased, 44 Union Square asset.

44 Union Square

Information can be found here related to the Retail and Office portions of this beautiful, newly completed building on the northeast corner of Union Square in Manhattan.  Significantly, Reading disclosed the following at its shareholder meeting in December 2021: “ We are working with a leading national retailer to take three floors to create a flagship store with a targeted rent start of 2022.”

Given this news, here is a valuation range for the 44 Union Square asset with estimated rental rates, operating expenses and cap rates.  Clearly the timing of leasing the office portion, assuming the aforementioned retail deal closes, is key to valuation.

Returning to the SOTP valuation above, if we plug $100mm into the real estate line item for 44 Union Square, we are more than comfortable with the balance of the real estate assets at the implied $150mm aggregate valuation as a conservative valuation.  These assets include the following:

UNITED STATES

Patton Vision Pro Forma Valuation

As noted above, Reading received take over offers in recent years (pre-COVID).  The most recent, in November 2018, which was reiterated in March 2019, from Patton Vision, LLC (“PV”) et al, valued the enterprise as follows:

Adjusting the 3/20/19 Patton Vision offer price for the real estate assets Reading recently sold, we get a pro forma adjusted offer as follows.  

Now, compare the implied (admittedly pre-COVID) pro-forma valuation for Reading adjusted for the asset dispositions to its current market cap:

There is no question that COVID has hurt the cinema business and the real estate market.  However, we believe these impacts will prove temporary and are waning as people adjust to perhaps a new normal (see blockbuster numbers for the newly released Spiderman: No Way Home and the huge backlog of potential blockbusters whose releases have been delayed by studios).  Some say the cinema business is facing an existential threat from premium video on-demand (“PVOD”) and the continued reduction or elimination of the theater exhibition exclusivity window.  Again, while we acknowledge a potential impact from these changes, we do not see them as fatal to theater exhibition.

Regardless of your view on these two changes to cinema-going, do they add up to a 57% discount to the value that a sophisticated buyer, who was aware of PVOD though not COVID, put on the assets as an opening bid?

Reading has $90mm of cash on the balance sheet, no material debt maturing until 2023, and additional discrete real estate assets to monetize if more liquidity is needed.

If we assume that COVID variant after variant impact movie-going for the next two years and Reading burns roughly the same amount of cash in 2022 and 2023 as it did on an annualized basis in 2021, we would see the following: 

Valuation Summary

Is a discount of this magnitude warranted today?  We think not.

Why is it cheap?

• Covid impact on operating businesses; fear of renewed closures, etc.

• Investor frustration with slow pace of litigation and uncertainty about resolution

• Misalignment of interests between Cotter management/controlling shareholders and other shareholders 

• Tax loss selling at YE 2021

Risks

• Extended COVID/new variants that result in lockdowns impacting the cinema business, the leasing of 44 Union Square, and re-leasing existing properties

• Poor capital allocation by management/board

• Litigation outcome that does not compel a sale of RDIB controlling block

RDI vs. RDIB

Reading’s two share classes are similar economically, but differ in voting rights.  The divergence of the share prices has not always existed as the chart below shows.  Thin trading in the limited float RDIB is certainly part of the explanation.

Historical prices of RDI and RDIB

RDI and RDIB Stock prices 2008-2021

Note: Crosshairs indicate the date of Senior’s passing.  Patton Vision’s initial bid was in Summer 2016

Catalyst

Expected lease of retail at 44 Union Square

Omicron fears subside (and are not replaced…)

Spring/Summer 2022 “tentpole” movie releases to pent-up cinema experience demand

Litigation resolution (longer term catalyst)