FOOL ON THE HILL: An Investment Opinion
With all the great new stadium seating theaters, you might think that movie theater exhibition stocks are doing well. In reality, stocks of the three largest companies in the industry have fallen 70%-80% over the past year. The companies took on excessive debt to build too many screens, putting them in a precarious position. Time will tell if slower growth can resuscitate any of these companies.
The three largest publicly traded theater companies (based on numbers of screens) are Loews Cineplex Entertainment (NYSE: LCP), AMC Entertainment (AMEX: AEN), and Carmike Cinemas (NYSE: CKE). All of their stocks are down 70%-80% over the past year. The losses are even greater if you go back a year or two further, when excitement over the evolution of stadium-seating megaplexes reached its peak.
These companies have been hammered by the perils of competitive marketplaces, exacerbated by debt markets that were willing to reach their hands out too far.
The idea behind megaplexes is quite simple: open one up and patrons will flock to them. Moviegoers love the amenities and the larger number of screens enable showtimes to be staggered to better fit customers schedules. With the large number of various-sized screens, theaters can shift films around to better match supply with demand. Having one large facility with centralized concession stands and ticket sales helps leverage operating costs over a larger base, increasing profitability. It's a theoretical win-win situation.
Of course, reality doesn't always turn out like people plan. Several factors combined to turn grand growth plans for these chains into financial fiascoes. As you read ahead, keep in mind that building new megaplexes takes a hefty chunk of cash, generally financed with debt or leases. Movie theaters' cash flow was considered fairly stable, so it wasn't too hard to get financing.
The competitive dynamics of the marketplace led to massive expansion of megaplexes over the past three years. Part of this growth was driven by the great economics of new units, but it was also based on competitive positioning. If a company didn't build new theaters in its existing markets, it risked having a competitor come in and take away its customers.
As a preemptive move, many chains built new megaplexes near existing theaters, even though it destroyed the profitability of the older theaters. That's not too surprising -- would you rather go enjoy a new, stadium seating theater or hit an old joint that hasn't been rehabbed in 12 years?
The disappearing cash flow from older units has been the biggest problem facing movie theaters. All of the theater circuits have closed, sold, and/or written down the value of their older venues. Nonetheless, they are still facing deteriorating results. According to AMC's annual report, its older multiplexes experienced a 14.6% decline in attendance over the past year -- and that's on top of a 11.7% attendance drop the prior year.
The financial challenges of new competition would have been somewhat mitigated if the explosion of new theaters dramatically expanded the theater-going audience. Based on the numbers, however, this didn't happen. The number of movie screens increased 9% in 1999, yet it took three years -- from 1996 to 1999 -- for attendance to achieve that same level of growth! With the dramatic explosion in available screens, even new megaplexes are suffering from lower patronage.
Although movie attendance has increased only slightly, box office revenue has increased more dramatically due to ticket price increases. Over the past three years, box office take has jumped up 26%. This gain has been eaten up, however, by the higher costs of operating so many more theaters. In addition, movie studios are getting a larger portion of the box office because movies are not staying in theaters as long. (Chains typically pay movie studios a percentage of the box office that starts off high -- 60%-70% -- then drops down to as low as 30% over four to eight weeks.)
Most of the chains have realized the challenges being faced and have slowed down their expansion plans. After spending $170 million net on capital expenditures in 1999, Carmike Cinemas in only planning to shell out $22 million this year. AMC is dropping its net capital expenditure budget by at least 25% and it looks like Loews Cineplex will also slow down growth. (It's hard to tell how much these reduced capital expenditures are caused by rational economic analysis and how much is being forced by lenders unwilling to extend any more credit.)
Theater operators may begin to see results improve from the massive losses they are now experiencing if new theater expansion really slows down. The question investors now face is figuring out whether the companies took on too much debt to survive. Bonds issued by many theater exhibitors are yielding 15%-20% or more, indicating a belief that they may not be paid off.
Theater management teams now must struggle with the complicated task of generating free cash flow to reduce debt and maintain competitive offerings. One or two of these management teams may be up to this task, but I doubt all of them will. The most likely to fail are those companies spending money as if they don't need to generate free cash flow.