Saturday, March 29, 2014

March '14 manufacturing ISM guesstimate ...

We estimate March manufacturing ISM of 54.4, slightly higher than the 54.0 consensus, and somewhat of an improvement from February's 53.2.  After seeing improvements in some of regional manufacturing survey results, especially in the Philadelphia Fed survey, combined with so-called 'weather factor', which may have created a so-called pent-up demand the last couple of months, we think there was a slightly bigger 'bounce' in March than what many economists have estimated.  We note that even with our more 'optimistic' projection of this widely-followed macro indicator, we continue to believe that the overall equity market is overvalued. The manufacturing ISM index will be released on April Fools' Day at 10am(EST).

We will provide our estimate for BLS' employment report (to be released on Friday, 4/4, at 8:30am(EST)) on Wednesday afternoon, 4/4.

AVID: Revisiting Avid Technology, Inc.

We are revisiting Avid Technology (AVID), a company that makes software and hardware that companies within the media and entertainment space use to create, edit, and add effects to film, video, and audio; in other words, its products help enhance and increase value of digital media assets.  The Company has improved its products to not only enable content creation and enhancement, but also to help secure and monetize those digital media assets efficiently.  AVID remains a turnaround story; not only in terms of improving the top and bottom-line, but also to get relisted on NASDAQ.  We think the stock could be worth $11.18, but investing in this name requires patience.  We will discuss why the stock is where it is, and also will touch on what we consider to be near-term and long-term catalysts that could push it higher.  We will then discuss our estimates and valuation in a bit more detail. 

We introduced AVID in Dec. ’12 with a $9.00/sh valuation.  At that time the stock was at $6.83.  As shown below, since then, it has had its good and bad days.  The stock hit $8.00 a few times and went as high as $8.89 in Dec. ‘13.

During those 16 months, the Company encountered many issues, the main one being that it had to review the way it treated software maintenance revenues.  This was related only to the timing of revenue recognition, not the total amount of revenues that it generated.  In addition, according to management, the necessary restatements (due to the accounting review), which have not been completed yet, will not impact cash receipts related to those revenues.  Given that the Company could not complete its review nor file quarterly and annual results (since Q3 ’12), its stock was delisted from NASDAQ on Feb. 25 of this year.  As shown in the chart above, the stock slid 25% on Feb. 24 and closed at $4.93.  The stock has recovered a bit since then, as management finally provided some color regarding not only the review process but also the Company’s forward strategy.

Foreseeing a significant downturn in the stock due to getting delisted from NASDAQ, the Company also introduced a flip-in poison pill plan on Jan. 7, hoping that its possible dilutive effect on AVID shares would turn away potential acquirer(s) or force it to pay much more.  This could also be viewed as AVID having confidence in completing its restatements, getting relisted on NASDAQ, and improving its operations, which hopefully would push the stock higher. 

Below are what we view as near-term catalysts for the stock. 
  • Presence at the upcoming NAB (National Association of Broadcasters) conference; April 5 - 10.  AVID likely will impress investors, in addition to current and potential clients, with its latest product strategy and demos.  The Company also will be hosting its first ACA (Avid Customer Association) event, Avid Connect.  AVID, along with its clients and media industry leaders, created ACA to have a better perspective of the current and future state of the industry, and to develop future strategies.  We think some investors also may attend Avid Connect, where they will witness its customer brand loyalty and AVID’s role in the industry. 
  • Completion of all restatements and filings, which management believes will take place by “mid-year 2014”. 
  • Positive press releases about AVID’s new contract signings or extensions, and its role in helping media companies cover important US and international events, including the 2014 World Cup and US midterm elections. 
  • Applying for relisting of AVID stock on NASDAQ.  If the Company completes its SEC filings by mid-year, we think the application will be filed in Q3 or Q4. 

Long-term catalysts include:  
  • Revenue growth driven by new products and product upgrades, in addition to widely covered US and/or international events (slightly seasonal) 
  • Margin expansion post divestiture of the consumer business, and further driven by cost control, and likely higher recurring revenues 
  • Return to breakeven or profitability by end of FY ‘15

Revenue growth

AVID is introducing new products and strategies which will help drive revenues higher.  Its most recent one is Avid Everywhere (basically an upgrade of Interplay), which the Company will demo and discuss in more detail at ACA and the NAB.  

Given the digitization of media assets and the many sources of content and increasing number of content creators, media companies likely are embracing more enhanced centralized (or cloud-based) media asset management systems, where media asset flow and information flow are integrated and managed efficiently, from the content creation process to its protection, distribution, and monetization.  AVID is enabling its clients to do this through the open and integrated Avid Everywhere platform.  In addition to AVID’s own widely-used tools and applications, third-party products can sit on this platform.  

Continuing trends such as increase in creation and distribution of 3D content, prioritization of not only distributing and monetizing but also creating and editing content anywhere in real-time, and, of course, the continuing transition towards HD content (now mainly in emerging markets), and lower bandwidth costs likely will drive up demand for offerings such as Avid Everywhere.  We think this may also help AVID become more of a SaaS (software as a service) company.

Large events also drive some top-line growth for AVID.  The Company has been successful in selling new products or upgrading products before widely covered US and/or international events.  Sales generated by such events usually close 2 - 3 quarters before the actual events take place.  Looking ahead, we believe the next US Presidential election plus the Summer Olympics in 2016 could drive more top-line growth in the second half of FY ’15.

We have modeled a 5.7% 5-year revenue CAGR ending in FY ’18.  We note that FY ’12 and FY ’13 numbers are our own estimates, as again, AVID has not filed its quarterly and annual financial results since Q3 ’12.  We think total revenues declined in FY ’12 and FY ’13 partially due to the Company divesting its consumer business in Q3 ’12.  That business was no longer growing, although we estimate it was still generating annual revenues between $90MM and $100MM.

As a software company moving towards a SaaS business model, or focused on selling its ‘everywhere’ media asset management solutions, we believe AVID’s software maintenance revenues, or services revenues, not only will begin to grow a bit faster than its product revenues, but will also become more recurring over time.  We expect to see more deferred revenues on AVID’s balance sheet going forward (once it begins filing its quarterly and annual results!).  We estimated a 7.6% 5-year CAGR for services revenues compared with 5% for products. 

Margin expansion  

We expect margin expansion, driven by modest revenue growth, more recurring revenues, lower amortization costs, and as mentioned previously, divestiture of the lower-margin consumer business.  While the Company may have improved gross margins in FY ’12 and FY ’13 (based on our estimates), we think it was more than offset by costs associated with restructuring and accounting review.  Based the Company’s first three quarters’ financial results in FY ’12, we estimate it incurred restructuring costs of nearly $29MM during that fiscal year.  In addition, based on AVID’s 8-K filings we plugged in accounting review costs of approx. $18MM and $34MM in FY ’13 and FY ’14, respectively.  Assuming not much additional restructuring costs going forward, we look for AVID’s operating margin to turn positive in FY ’15, 0.5%, and increase to 5%+ by end of FY ’18.  We estimate adj. EBITDA margin to grow from 4.5% this year to 9.1% in FY ’18. 

With all of this said, we expect AVID to breakeven or generate net income by end of FY ’15, which will be welcomed by the Street.


In terms of valuation, we did a 5-year DCF and came up with $9.23/sh equity value for AVID.  After adding what we expect is $1.95/sh in tax savings by carrying forward its US net operating losses (NOLs), we think AVID could be worth $11.18/sh, which represents an 82% upside.  We note that without assuming carryforward of the NOLs, upside is 50%. 

Our terminal multiple DCF model assumptions include EBITDA multiple of 7.0 and WACC of 14.1% (mainly due to AVID’s high beta of 1.8).  We are conservative in our assumptions as the multiple applied is lower than where most of AVID’s competitors are trading at.  This also goes along with our belief that the overall equity market is overvalued.  We think the lower EV/EBITDA also takes into account some of the risks with which the stock is associated, such as whether the Company can finish its accounting review and restatements, and improve its operations, on time.  The implied long-term growth rate of this model is 5%, which we believe is in-line with the ever-changing media industry and growth opportunities it may provide for software technology companies such as AVID. 

We looked at AVID’s NOLs which it can use for tax savings once it becomes profitable.  At the end of FY ’11, according to the Company, it had approx. $362MM in US NOLs.  We think that grew to $389MM by end of FY ’13 and will likely grow to $405MM this year.  Our $1.95/sh in tax savings is the sum of estimated PV of possible tax savings during FY ’14 – FY ’18, $4.7MM; and PV of tax savings post-FY ’18, $71.4MM, based on the remaining NOLs.  We assumed 41% of AVID’s revenues are generated in the US and a 35% tax rate, and used those figures to estimate the tax savings.

Again, investing in this name carries risk and requires patience, but we think given its high-quality and widely used products, combined with management’s attempts to run the Company more efficiently, the upside is attractive. 

Friday, March 21, 2014

AMC, CKEC, CNK, RGC: Some thoughts on movie theatres ...

AMC, CKEC, CNK, and RGC have not behaved the way we thought they would since the last time we discussed them.  So we thought we should conduct more detailed valuation of the companies rather than just a back-of-the-envelope calculation.  We note that we were long in 3 of these names and realized good returns, but it appears that we got out too soon.  Then again the entire market has gone up and up and ... yes, up.

While the movie theatre space is mature with intense outside competition, its main participants are growing revenues at modest rates, continue to generate positive cash flow, and remain profitable.  Most of them are also rewarding shareholders with dividends.  We will touch on the industry and the challenges it is facing today and going forward.  Then we will discuss four of its major players - Regal Entertainment Group (RGC), AMC Entertainment Holdings (AMC), Cinemark Holdings (CNK), and Carmike Cinemas (CKEC).  Based on our valuation of the companies we think AMC is fairly valued, RGC and CNK are under-valued, and CKEC is slightly over-valued. 

The U.S. movie theatre industry, with total annual revenues of approx. $15bil, is a mature one facing a lot of competition in terms of content delivery, availability of content, and pricing.  Simply put, more and more substitutes for the movie theatres are popping up.  The larger players in this space have taken steps to address the competition and hopefully to accelerate growth. 

In attempting to differentiate themselves, movie theatres have increased their capital expenditure to enhance their theatres (upgrade sound systems, install reclining seats, etc.) and expand their complementary services, such as adding more different types of foods and beverages, including alcohol. 

In terms of growth, the strategy has been to grow via acquisitions.  Many are also investing in alternative content, hoping to fill the seats.  Content remains king in this space and the content that lures moviegoers and brings in 90%+ of admission revenues is blockbuster films.  Based on the 2014 and 2015 film release schedule provided by Box Office Mojo (, we should see many box office hits during the next 24 months. 

Consolidation within the industry 

The maturity of the industry has led to more M&A in the space, as larger companies continue to acquire smaller ones in order to accelerate growth, make their operations more efficient, and hopefully to have a bigger say in pricing when negotiating with studios and distributors. 

We look for more acquisitions by larger players, but not as much as we have seen in the last 3 - 5 years.  Given how the equity market is valuing the main movie theatres currently, it is likely that the acquisition targets will demand higher EBITDA multiples; more than the 4x - 6x that we have seen in the past. 


Competition against this industry remains intense.  It includes in-home entertainment such as watching movies on DVD, via cable and satellite companies’ video-on-demand (VOD), or by subscribing to OTT (over-the-top) or streaming content providers such as Amazon (AMZN), Google (GOOG), Netflix (NFLX), and Hulu.  Prices for these methods of content delivery are lower than average price of movie tickets.  In addition, consumers have access to large libraries of content, helping to satisfy their spontaneous urge to watch something.  This is why movie theatres have been investing in upgrades – to make it worthwhile for consumers to get out of their homes, drive to the theatres, and pay higher prices for the movie and food. 

Theatres do have the advantage of showing newly released movies, especially the big hits, for a period of time before they are released in other media.  Under agreements signed with studios and distributors there is a ‘theatrical release window’ giving theatres exclusive rights to show movies on the big-screen for an average of 3 – 4 months.  Such release window helps theatres differentiate themselves from other media by showing the newest films first.  After the theatrical release window, movies become available on DVD, then on VOD and OTT, and finally after a couple of years, on television. 

Studios have done this to prevent revenue cannibalization that would occur if movies were released in all types of media at the same time.  Such theatre-advantage could be diminishing as studios have been testing to see the impact of shortening theatrical release windows.  As displayed in the graph below, release windows have been getting smaller since 2000.  This is driven mainly by consumers becoming less patient and demanding to see newly released movies anytime, anywhere, and via any device or platform.    

Source: NATO (National Association of Theatre Owners)

Overview of business model and the market 

There are basically three types of revenues that movie theatres generate: admission revenues from tickets they sell to consumers to view the content; concession revenues from the variety of foods and drinks they sell to their customers to make the movie viewing experience more enjoyable; and advertising revenues.  In our opinion, the main driver for all of these revenues is the quality and popularity of content, the movies.  Popular movies bring in more movie-goers, which then will lead to more purchases of concessions.  And the larger audience will enhance potential ROI on advertisements, which means more ads will be sold. 

Theatres pay studios and distributors for films on a sliding scale, meaning the higher a film’s national box office receipts, the larger percentage of admission revenues theatres must pay the studios and distributors.  These costs, usually referred to as film rents, are between 45% and 55% of admission revenues.  Given that 90%+ of admission revenues come from the big hit movies, we believe suppliers have some advantage when negotiating film rent agreements with exhibitors. 

Concession revenues make up approx. one-third of total revenues and they come at a cost of between 12% and 15% of revenues.  

After accounting for facility leases and other operating expenses, EBIT margins for the main players in this space run in the low to mid-teens.  EBITDA margins range from 15%, for companies such as AMC, to 20%+ for companies like CNK.

Most companies have increased their capex as they develop new theatres, and upgrade and expand current and newly acquired ones.  Capex is running between 3% and 10% of total revenues, depending on the size of the company and its growth strategies. 

While over 90% of screens in the market have been upgraded to digital, we believe this figure is not applicable to the remaining theatres that are acquisition targets.  Foreseeing the higher costs associated with upgrading newly acquired or current theatres to digital, acquirers have chosen to finance those investments.  For example, AMC, RGC, and CNK did a joint venture called Digital Cinema Implementation Partners (DCIP), where they secured over $600MM in financing to convert over 14,000 of their screens.  The companies pay back with a fixed payment per screen and a royalty fee of $0.50 per ticket sold.  CKEC did a digital upgrade agreement with Christie’s Digital Cinema business unit where CKEC will pay an installation cost per screen plus a fixed annual per screen maintenance fee. 

Higher prices driving revenue growth 

We estimate the industry generated approx. $15.0bil in total revenues during 2013.  Based on data from BoxOffice (, admission revenues, or box office receipts, grew at a 2.54% CAGR during the past 5 years.  In terms of attendance, the number of tickets sold grew at a 0.03% CAGR during the same period.  Clearly, the driver of growth has not been increase in attendance but instead, higher ticket prices.  As shown below, attendance began to decline in 2002, many years before the Great Recession. 


Although movie-going is considered something discretionary and not a necessity, and is dependent on disposable income, demand for such service has been price inelastic historically; a PED of 0.19 based on the average price of $8.13 (1990 – 2013).

Theatres have taken advantage of this as average ticket prices have increased 2.89% (CAGR) since 1990.  The latest 5-year CAGR of prices has been 2.52%, compared to annual inflation of 1.64% (based on core CPI).  This is positive for the industry, but continuing price increases could impact attendance more negatively than in the past.

Demand becomes less inelastic as prices increase.  The chart below shows the marginal impact of average price on PED in the movie theatre industry.

For example, if average price increased to $10.00, PED would likely go to 0.23.  If average price increases to $15.00, it would result in a PED of 0.30.  Again, overall, with higher prices, attendance is likely to remain inelastic, but to a lesser extent, which means it could continue to decline.  We note that average prices for RGC and AMC are already higher than $9.00, which is above industry average.  We look for RGC’s and AMC’s average ticket prices to go above $10.00 in 2018 and 2016, respectively.

Economists expect disposable income to increase at an annual rate of 2.5% during the next five years, which is positive for this industry, and could partially offset the negative impact of higher prices on attendance.  But it will also allow exhibitors to take more chances and possibly increase their prices at a higher rate, making overall attendance even more price sensitive.

Higher prices as driver of growth in this space will increase risks for theatre operators.  Risks have already increased as given the very modest growth going forward, companies are forced to differentiate themselves from substitutes by increasing capex and allocating a bigger portion towards making their theatres fancier and creating the in-home entertainment feel.  This will push them to continue to raise prices in order to generate respectable return. 

In pursuit of other content 

To partially offset higher risk, movie theatres are trying to maximize their capacity utilization.  In other words, they are trying to fill more seats during times that most people do not go and see popular films - Mondays through Thursdays.  To do that, movie theatres need cheaper content as theatres won't be as full as they are during 'normal' movie-going times.  This means if they pay high film rents for popular films, their ROI during those times will be significantly lower.  For this reason, theatres are now pursuing the cheaper alternative content such as documentaries, showing of live events, more independent and small-budget movies, short films, etc., more aggressively. Whether this strategy will help diversify revenues and enhance returns on theatre upgrades remains to be seen. 

We also believe theatres’ investments in making movie-going a fancy event rather than the casual leisure activity it has been in the past could be questioned, especially when combined with investing in alternative content.  We do not think many are willing to consistently pay a premium to sit in the reclining seats and be served food while watching alternative content or non-box-office hits.  This means theatres are likely to become more dependent on high-grossing films.  The good news is that studios continue to produce box office hits.  The not-so-good news is that the higher the box office receipts, the higher percentage theatres will have to pay studios and distributors, due to their contracts being based on a sliding scale formula.

Overall, the industry has had a good start this year as combined domestic box office revenues for January and February were up 10.3% Y/Y.   This is partially due to more movies being released in Jan. ’14 compared to Jan. ’13.  For movie theatres, the more is of course merrier.  And many box office hits are expected to be released during the next 24 months. 

Larger players in the movie theatre space 

We will focus on the four largest companies in this space: Regal Entertainment Group (RGC), AMC Entertainment Holdings (AMC), Cinemark Holdings (CNK), and Carmike Cinemas (CKEC).  All of these companies face the same type of competition that we touched on earlier, in addition to competing against each other in some markets. 

Overall, we see modest revenue growth for these companies during the next five years with some margin expansion.  Metrics for these companies, especially the ones paying dividends, are attractive. 

In valuing the companies, we applied the terminal multiple DCF model.  The exit EBITDA multiples we used are based on how the equity market values each company’s peers on trailing 12-month (TTM) EBITDA.  We also looked at the long-term growth rate that each model implies, which we think could provide support for or discredit the market’s valuation of the companies. 

Tables below provide some operating and key valuation metrics for each company.  We note that all projections are our own.  We broke out CNK's operating metrics into U.S. and international, as unlike its peers, CNK's international segment generates a sizable chunk, nearly 30%, of its total revenues.  

Regal Entertainment Group (RGC) 

RGC is the largest movie theatre company in the U.S. as it operates more theatres and screens than the other three companies.  It has a market cap of $3.0bil. 

The Company’s average ticket price of $9.01 in 2013 was already above the industry’s.  Given the top metropolitan areas that it serves, we believe it can continue to raise prices at 2.5% - 3.5% per year, slightly above the inflation rate.  However, once the average price goes above $11.00 we believe the higher price can no longer offset more significant decline in attendance.  We estimate RGC ending FY ’18 with average ticket price of $10.19. 

We expect 5-year CAGR of 5.9% and 4.3% for RGC’s EBIT and EBITDA.  Combined with 4% CAGR in total revenues, this translates to 260bps and 150bps EBIT and EBITDA margin expansion during the same period. 

Other assumptions and estimates such as number of theatres operated, number of screens, attendance, concession revenue per attendee, etc. are provided on table shown previously. 

RGC has been aggressive in upgrading its theatres for the past four years.  For example, in 2010 it initiated its RPX (Regal Premium Experience) project which is basically an auditorium with luxury seating, wall-to-wall screens, and an enhanced sound system.  The Company can utilize such multi-purpose indoor venues for other events.  This is another example of companies in this space trying to fill the seats as often during the week as possible. 

RGC, along with AMC and CNK, has also been installing IMAX (IMAX) digital projection system, which makes the images much clearer, especially for larger or wall-to-wall screens.  A portion of revenues generated in IMAX-installed theatres goes back to IMAX.  However, we note that agreements with IMAX are geographically exclusive.  For example, if RGC has installed IMAX in a certain area, others such as AMC with theatres in the same area cannot install IMAX. 

Of course, premium experiences brought about by RPX, IMAX, and enhanced dining (improvements in foods and beverages) require movie-goers to pay higher prices. 

Regarding improvements in dining, there is a risk that this will not pay off in the long-run given that most of RGC's theatres are in top DMAs which are metropolitan areas.  In these more densely populated areas, there are more and higher quality options for premium movie-goers to choose from before or after seeing a movie.  But again, concession revenues are dependent on attendance at movie theatres, and RGC's attendance per screen has been declining.  While higher prices may help top-line growth, we view their negative impact on attendance (in addition to other options available to viewers) as a long-term risk. 

In terms of advertising revenues, RGC, AMC, and CNK founded a company called NCM (NCMI), which brings in ads to be shown on screens prior to the main show.  NCMI refers to this as FirstLook.  NCMI is an $867.8MM company trading at 7.3x TTM EBITDA with an EBITDA margin of around 48%.  In addition to ads, NCMI produced and distributed pre-recorded and live events.  This segment, Fathom Events, was spun-off in Dec. '13.  After the spin-off, RGC owns approx. 20% of NCMI and 32% of Fathom Events (or AC JV, LLC). 

RGC, AMC, and CNK are hoping that Fathom will help bring in alternative content and non-film entertainment for their theatres. 

More on the content front, RGC also co-owns Open Road (with AMC) which may help bring in smaller budget films, again, to fill the seats.  We actually think Open Road and Fathom should merge to create a stronger and more diverse alternative content provider. 

Steps have also been taken to reduce some costs associated with getting the film from studios or distributors.  RGC, along with AMC and CNK, is part of the Digital Cinema Distribution Coalition (DCDC), a JV that helps deliver digital content to theatres via satellite.  Companies such as RGC believe this may reduce film transportation costs and provide more flexibility in delivering other content.

Regarding how we think RGC will perform going forward, below are some historical numbers and our projections for the next five years.  

Based on our 5-year DCF model (more detail provided below) and RGC's 20% stake in NCMI, we value RGC at $26.09/sh.  

We note that given the Company's negative equity, we used its current market cap as equity in calculating WACC.  RGC’s negative equity is due to it paying large special dividends after its IPO in 2002.  The Company paid a $5.00/sh dividend in Jul ’03 and a $5.05/sh dividend in Jun ’04. 

For the terminal multiple, we used the average of its peers’ TTM EBITDA multiple.  The terminal multiple DCF model implies a long-term growth rate of 0.77%, which we believe is low even for such a mature industry.  We think a range of 1.5% - 2.0% is more appropriate.  In fact, economists have projected a long-term U.S. economic growth trend of around 2%.  The low implied growth rate provides support for our belief that RGC is undervalued. 

AMC Entertainment Holdings (AMC) 

AMC is the second largest company within this group, in terms of the number of theatres and screens it operates in the U.S.  It is valued currently at $2.3bil.

The Company did an IPO in Dec '13 only about 15 months after being acquired by the Chinese conglomerate, Dalian Wanda Group for $2.7bil.  Wanda still owns nearly 80% of AMC.  The IPO appears to have been a successful one as AMC's stock price has increased 31% from the IPO price of $18.00/sh. 

AMC’s average ticket price of $9.27 in 2013 was already the highest in the industry.  Similar to RGC, given the top metropolitan areas that AMC serves, we believe it can continue to raise prices at 2.5% - 3.5% per year, slightly above the inflation rate.  However, once the average price goes above $11.00 we believe the higher price can no longer offset more significant decline in attendance.  We estimate AMC ending FY ’18 with average ticket price of $10.58.  

We expect 5-year CAGR of 13.5% and 6.5% for AMC’s EBIT and EBITDA.  The higher EBIT growth rate is due mainly to the significantly lower stock-based compensation that we have estimated for the next five years.  Combined with 4.1% CAGR in total revenues, growth in EBIT and EBITDA translates to 290bps and 150bps margin expansion, respectively.

Other assumptions and estimates such as number of theatres operated, number of screens, attendance, concession revenue per attendee, etc. were provided in a previous table.

Compared with RGC, AMC is upgrading its theatres and acquiring other ones more aggressively.  It is using RealD 3D systems, in addition to IMAX's digital projection systems.  AMC also introduced its own version of RGC's RPX, ETX, in March 2010.  It appeared that the implementation of ETX became an urgent matter as the famous comedian, Aziz Ansari, was angry about paying extra to see a movie in AMC's IMAX theatre which, according to Ansari, had a much smaller screen than he expected.  

Unlike RGC, AMC's attendance per screen increased in 2013 compared with 2012.  We think it was due to the Company's more aggressive marketing, especially prior to its IPO.  Given the Company's higher average ticket prices than its peers, we believe attendance per screen will begin to decline this year but will likely stabilize through 2016, after which it will again decline due to higher prices which we estimated to be an average of $10.44.  But this does not mean that revenues will also decline given the higher prices.   

AMC will also enhance its food and beverage offerings (concessions).  But we think it will need to be more aggressive than its peers given its theatre locations.  AMC's theatres are mostly in very densely populated metropolitan areas, similar to RGC.  There are more and higher quality options (substitutes) for premium movie-goers to choose from in these areas, before or after seeing a movie.

As mentioned before, AMC also has ownership in NCMI and Fathom, approx. 15% and 32%, respectively; and it co-owns Open Road with RGC.  It is also participating in the DCDC strategy of having content delivered to theatres via satellite.

Overall, AMC's strategy is similar to RGC's: upgrade theatres, try to enhance the moviegoing experience with reclining seats and better foods and beverages, and hope that movie-goers will continue to pay higher prices.  

Below are our AMC projections for the next 5 years.

Based on our 5-year DCF model (more detail provided below) and AMC's 15% stake in NCMI, we value AMC at $26.60/sh.  

We could not find nor calculate AMC’s beta, as the Company’s stock began trading in the secondary market only recently.  For this reason, and given the Company’s similarities to RGC and CNK, we assumed the average of those two companies’ betas for AMC.  For the terminal multiple, we used the average of its peers’ TTM EBITDA multiple.  Based on the implied long-term growth rate of 3.55%, it appears that the applied multiple of 8.7, is a bit high.  We think a range of 1.5% - 2.0% is more appropriate for long-term growth.  In fact, economists have projected a long-term U.S. economic growth trend of around 2%.   In addition, our valuation of AMC represents only a 13.1% upside.  For these reasons, we view the Company as being fairly valued rather than under-valued. 

Cinemark Holdings (CNK) 

CNK is currently valued at $3.3bil.  Approx. 30% of CNK's revenues come from its operations in the faster growing Latin America market. 

While the Company's strategy is similar to RGC's and AMC's, it appears management is a bit more conservative, not only in terms of upgrades, but also cost control, which by the numbers make it a more efficiently run company. 

EBIT and EBITDA margins of CNK's U.S. business have been higher than its peers' historically, and we think this will continue going forward.  The Company has accomplished this even though its average prices are significantly below its peers'.  The Company’s average U.S. ticket price of $6.95 in 2013 was below the industry’s.  Given the overall increasing price trend, CNK is positioned to up its prices more and accelerate growth.  However, not as much as RGC and AMC because the Company does not serve as many densely populated and high-traffic areas as those companies do.  For U.S., we have assumed price increase comparable to the expected rate of inflation, or around 2%. 

For Latin America, we have assumed annual price increase of less than 1% given that it is more price sensitive.  At the same time, we believe attendance in those markets will be more stable than in the U.S.  And given the higher growth potential of that region, we think advertisers have been eager to tap into those markets, which is why we estimate an 8.14% 5-year CAGR for ad revenues generated in Latin America. 

We note that more risk is also associated with the Latin America market, in terms of more volatility in overall economic growth, disposable income, and the not so predictable impact of currency exchange rates. 

Other assumptions and estimates such as total number of theatres operated, number of screens, attendance, concession revenue per attendee, etc. were provided on a previous table. 

As mentioned earlier, CNK is also upgrading its theatres, but not as aggressively as RGC and AMC.  It began opening what it refers to as XD auditoriums in 2010.  It is following that up with further enhancements with its NextGen concept. Similar to RGC and AMC, XDs and NextGen include wall-to-wall screens, better sound systems, luxury seating, and more variety of foods and beverages.  CNK has also utilized IMAX's technology, along with 3D screens from RealD.  However, again, the premium that it charges is lower than the other companies. 

The Company has a 19% share in NCMI and 32% in Fathom.  It is also participating in the DCDC strategy of having content delivered to theatres via satellite. 

Overall, although CNK will face the same obstacles as other players, we believe the Company operates its business more efficiently than its competitors.  The faster growing Latin American markets may provide more upside for CNK even with the additional risks that we discussed. 

Regarding how we think CNK will perform going forward, below are some historical numbers and our projections for the next five years.  

Based on our 5-year DCF model (more detail provided below) and CNK's 19% stake in NCMI, we value CNK at $36.26/sh. 

For the terminal multiple, we used the average of its peers' TTM EBITDA multiple along with an EBITDA multiple of 7.0 for its international operations.  We weighted each multiple based on percentage of total EBITDA that each segment represents.  The implied growth rate of 1.25% indicates that the terminal multiple is slightly low, even for such a mature industry.  We think a range of 2.0% - 2.5% is more appropriate.  In fact, economists have projected long-term U.S. and Latin America economic growth trends of around 2% and 3%, respectively.  The low implied growth rate provides support for our belief that CNK is undervalued. 

Carmike Cinemas (CKEC) 

CKEC is a bit different in terms of size and the areas that it serves.  It is a $759.5MM company with theatres mostly in small to mid-sized suburban markets.  In addition, the Company is not currently paying dividends. 

CKEC will be pursuing acquisitions aggressively during the next couple of years.  Management intends to have approx. 300 theatres and 3,000 screens by mid-2016, up from 252 and 2,660 theatres and screens, respectively. 

The Company’s average ticket price of $7.02 in 2013 was below the industry’s.  We expect CKEC to up its prices at nearly twice the rate of inflation, or 3.5% per year, for the next five years, resulting in average price of $8.34 in FY ’18.  However, CKEC will not be able to match the much higher average prices of RGC or AMC, as it serves markets in suburban areas. 

We expect 5-year CAGR of 12.6% and 7.2% for CKEC’s EBIT and EBITDA.  Combined with 6.2% CAGR in total revenues (driven by acquisitions and price hikes), this translates to 310bps and 90bps EBIT and EBITDA margin expansion during the same period. 

Other assumptions and estimates such as number of theatres operated, number of screens, attendance, concession revenue per attendee, etc. were provided on a previous table. 

Unlike its peers such as CNK, CKEC has not yet upgraded 100% of its theatres to digital.  According to the Company, 95% of its theatres and 96% of its screens are digital.  For this reason, some of CKEC’s current and newly acquired screens will need digital upgrades, a service provided via its agreement with Christie’s Digital Cinema.  As mentioned earlier in the report CKEC’s agreement with Christie requires an upfront installation cost plus a fixed annual maintenance fee per screen.   Given that this increases CKEC’s fixed costs, the upside in terms of margin expansion becomes attractive as revenues grow.  However, it also carries a risk to the downside if revenue growth decelerates.  RGC, AMC, and CNK’s DCIP arrangement creates more of a variable cost for those companies given the royalty they will pay DCIP per ticket sold.  Although the upside may not be maximized in terms of margin expansion, this model does provide some downside protection for those companies if attendance per screen declines more rapidly. 

CKEC’s own version of RPX (RGC’s), ETX (AMC’s), and XD (CNK’s) is referred to as BigD.  The Company has also installed IMAX’s digital systems in some of its markets. 

Regarding ad revenues, CKEC is not working with NCMI, but it has an agreement with a similar company, Screenvision, which is owned by a holding company, SV Holdco.  CKEC has a 19% stake in SV Holdco. 

CKEC does have one advantage – people that live in the suburban areas, in which most of its theatres are located, are less likely to have as many other leisure activity options as the people that live in urban areas do.  For this reason, we expect attendance per screen to remain constant going forward as opposed to declining which may be the case with the other companies. 

While we touched on some risks associated with investing in expanding foods and beverages offerings for other companies given where most of their theatres are located, we do not believe the same applies to CKEC.  There will not be too many substitutes for moviegoers when it comes to dining or foods and beverages in suburban areas.  In fact, we believe the ‘one-stop shop’ strategy (having restaurants inside auditoriums) could be effective for CKEC’s theatres.  Although content remains the main driver behind attendance, in areas with less options available it could be the other way around, where initially some come in for the food and may follow that with purchasing tickets to watch a movie. 

Below are our projections for CKEC for the next 5 years.   

Based on our 5-year DCF model (more detail provided below) we value CKEC at $30.08/sh.

For the terminal multiple, we used the average of its peers’ TTM EBITDA multiple.  The implied long-term growth rate of 5.73% indicates that the applied terminal multiple is too high for this company.  We think a range of 1.5% - 2.5% long-term growth is more appropriate for CKEC.  We think it could be as high as 2.5% (compared with the 2.0% that we suggested for RGC and AMC) because it is more likely that consumers in suburban areas will use a higher percentage of their disposable income consistently to watch movies than those that live in more densely populated areas.  As mentioned before, economists have projected a long-term U.S. economic growth trend of around 2%.

In addition, CKEC’s WACC is significantly above its peers’.   This is due to the much higher interest the Company pays on its capital leases and financing obligations (which we include as part of CKEC’s total debt) and on its senior notes, making its cost of debt much higher than the other companies’.  The much higher beta for CKEC also drives WACC higher.  With all of this said, in our opinion, when compared to its peers, CKEC is a riskier investment in addition to being just a bit over-valued currently.