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Theaters have cash flow, studios have risk.
Before the federal government declared it to be an anti-trust violation, movie studios also owned exhibition houses. There was a reason why the studios wanted to own the theaters.
Today, the studios don’t own exhibition but they do own distribution, and that makes them even more money. That includes ancillary distribution, like DVD and streaming. Distribution is more predictable — and thus safer — than exhibition since there is literally no possible way to forecast the box office revenues of a particular film.
It is possible to establish a floor of certain expected revenues based on various elements but an outright expectation of box office is not possible. The closer the film gets to release, the probability of a certain box office expectation increases.
But probabilities aren’t certainties. Because of that unpredictability, movies are an incredibly risky business. That’s why most studios have to be heavily capitalized. They need to have a portfolio of films because some will fail. That’s not entirely different from creating your own long-term, diversified investment portfolio.
Movie theaters are a different beast. A theater chain with multiplex cinemas can show lots of films at once, and vary how many screens a given film will play on, and for how long.
Theaters are guaranteed a steady stream of product. They don’t have nearly the same risks as the movie studios. Movie theaters’ business model is simple. They draw down debt and raise equity to build their chain. Then they make their money in two ways. The first part they can’t control – the type and quality of films released by the studios. All they can do is maximize square footage revenues while minimizing the cost per attendee.
Thus, theaters diversify the size of the auditoriums in each megaplex. Hunger Games may begin by selling out the four largest auditoriums in the first weekend, but further down the line, it may only require a single, smaller theater, while the large ones make way for the next blockbuster.
The goal is to maximize return on investment with the mix of films, number of theaters, and revenue shares with the studios, which are part of every deal.
The second source of revenue is concessions. This is hugely profitable, with giant margins. Theaters literally make a 10x return on popcorn and candy.
Cash flow is used to service debt, grow the chain and, at some point, pay a dividend.
So which chain is the best one to buy?
Cinemark Holdings (NYSE: CNK) has a big international presence that makes it somewhat attractive. It operates 488 theatres and 5,609 screens in 40 states, Brazil, Argentina, and 11 other Latin American countries. It pays a 2.8% yield. It has $800 million in cash and investments and a manageable $2 billion in debt. It has $100 million in free cash flow over the trailing 12 months (TTM), and has paid almost all of it out as dividends, so that’s something to be wary of.
Regal Entertainment Group (NYSE: RGC) is a cash flow-rich business. It’s got 7,400 screen in 534 theaters across 42 states. The dividend is generous at 4.2%. It has TTM free cash flow of $160 million and paid $136 million of it in dividends. Regal is fairly mature at this point, and often gives special dividends. It’s also putting itself up for sale, so it may be a value here.
AMC Entertainment Holdings (NYSE: AMC) was purchased by Chinese behemoth Wanda, and then spun off again as a public company. It has almost 5,000 screens in 32 states. It isn’t as cash rich as Cinemark, with only $155 million in cash and $1.88 billion in debt. It pays a 3.2% dividend, which it just started issuing this past quarter, but has flat free cash flow.
Carmike Cinemas (NASDAQ: CKEC) doesn’t pay a dividend although it has modest free cash flow. It sits on $97 million in cash and $447 million in debt. Its 2,670 screens should be producing more cash, which is why I’d avoid it.
The winner to me is Regal, with its solid cash flow and dividend, and likelihood of being taken out at a premium.
Buy it now before the holiday rush to the theater.
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