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Daily Trouble
October 29, 1999

Loews Cineplex Entertainment Corp.

Ticker: (NYSE: LCP)
Phone: 212-833-6275
Website: www.loewscineplex.com
Price (10/28/99): $7 3/8

By Paul Larson (TMF Parlay)

How Did it Find Trouble?

Rewind six months and one gets a completely different picture of what the stock of Loews Cineplex looked like. The hype surrounding The Phantom Menace was running rampant, and the entire movie theater industry was riding high on Wall Street. The industry was heading into its profitable summer season, and many were betting that profit growth was going to be vibrant and healthy.

While the summer did prove to be a relatively good one for the industry, with box office receipts up 18% for the season, the explosive growth that many were expecting proved to be elusive. Plus, Loews' proportionate share of the box office total actually fell slightly as the company's revenue only rose roughly 3% in the August quarter.

Beyond the hype dying down and killer growth not materializing, probably a more important factor behind Loews' recent difficulties is the amount of capital the company is spending on upgrading and repositioning its theaters. Competition in the movie business is heating up, and the operators are being forced to spend copiously to shutter older theaters while opening new megaplexes with the latest amenities, including stadium-style seating and digital sound. Once up and running, the newer theaters produce impressive cash flows, but they are fairly expensive to build. Many investors are looking at the great amount of money being spent on capital expenditures and wondering if there will be a sufficient return.

After peaking just below $13 in early May, the company's shares have been extremely weak of late. Just about anyone who has bought shares in the company over the past six months is giving the stock's performance a thumbs down.

Business Description

Today's Loews Cineplex was created by the merger of Sony Loews and Cineplex Odeon in May 1998. The company is one of the nation's largest movie theater companies, operating over 2,900 screens in 406 locations. Most of the company's theater complexes are concentrated in major cities.

Loews Cineplex is the largest publicly traded movie theater company in the country. Only the private Regal Cinemas has more screens than Loews. However, illustrating just how fragmented the movie theater business is, Loews only has control of roughly 8% of the industry's total screens.

The largest shareholders of Loews Cineplex are Sony Pictures Entertainment and Universal Studios. The two firms own 40% and 26% stakes, respectively.

Financial Facts

Income Statement
12-month sales: $941.0 million
12-month income: ($19.4 million)
12-month EPS: ($0.22)
Profit Margin: N/A
Market Cap: $432.3 million

Balance Sheet
Cash and Equivalents: $28.2 million
Current Assets: $59.8 million
Total Assets: $1,843.7 million
Current Liabilities: $194.3 million
Long-term Debt: $780.5 million
Total Liabilities: $1,184.0 million

Ratios
Price-to-earnings: N/A
Price-to-sales: 0.46

How Could You Have Seen it Coming?

One way to have anticipated the trouble with Loews Cineplex was to look at the company's balance sheet. The company is carrying a fairly high amount of debt, and this leverage increases the risk to equity holders. In the first six months of the fiscal year, Loews' operating income was completely wiped out by interest expenses.

Beyond the debt, the company's aggressive spending plan may have worried a few investors. Loews Cineplex said that it intended to spend roughly $1 billion on upgrades and new theaters over the five-year period following its May 1998 merger, and the statement of cash flows shows this spending. Even though the company had positive earnings in the most recent quarter, the firm was cash flow negative. Capital expenditures are surpassing the company's reported depreciation expense, and the net cash flowing away from Loews Cineplex has many concerned.

Finally, one may have looked at the competitive landscape of the movie industry and perhaps thought twice about investing in the industry. Even though there is modest growth here, the movie business is largely a mature one. Plus, the companies in the industry are being forced to spend like mad to keep up with Joneses. Such is life in an industry where sustainable competitive advantages are difficult to come by.

Where to From Here?

While Loews has an impressive position in its industry, the movie business as a whole is a mighty tough business in which to make a profit. The theater companies are aggressively trying to attract customers, and this means shelling out the bucks to build megaplexes with all the latest bells and whistles.

Unfortunately, this is quickly making the older theaters obsolete and candidates for upgrades or even closure. This doesn't come cheap, and Loews' already leveraged balance sheet will probably become even more leveraged.

Loews seems to be taking a rational approach to its expansion/upgrade path and keeping an eye on its bottom line, but there are some irrational competitors in the industry that are aggressively trying to grab market share. Not only does this expansion mean that the newer theaters are cannibalizing the older ones, but sometimes the new theaters are being built so close to one another that there are serious overcapacity concerns in many markets.

One may look at Loews' price-to-book ratio and think the shares may be a bargain at today's prices. However, it's worth noting that many of the assets on the balance sheet, namely the older theaters, are being carried at values much higher than their liquidation values. Loews Cineplex, like its peers, has been writing off its losses on these closings, which has a serious impact on profitability. Loews has said that it still has to close over 300 theaters over the coming months, most of which are underperforming locations acquired in the Cineplex Odeon merger.

Loews Cineplex is not expected to be profitable next year nor in the year after that. And even if the company does manage to report an accounting profit like it tends to do in the summer quarter, the cash flow dynamics at work in the industry in general and with Loews specifically have to give investors pause. Between operating in a difficult, mature industry with the capacity onslaughts, costly upgrades, and asset write-downs, there are more than a few reasons for investors to avoid this flick.

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