Cheers and Jeers: AMC to Acquire Carmike, Shake Shack Falls on Weak Guidance

Last week, No. 2 theater operator -- AMC Entertainment (AMC) -- moved to usurp the title of largest theater chain in the U.S. after announcing the $1.1 billion buyout of its smaller rival, Carmike Cinemas (NASDAQ: CKEC). This continues the recent trend of industry consolidation and gives AMC parent company, the China-based Wanda Group, a stronger foothold in Hollywood. The combined entity could boast a network of 8,000 screens and 600 locations in 45 states.

And as the current earnings season winds down, we discuss impressive results from the darling burger chain, Shake Shack (SHAK 1.85%). However, despite topping Wall Street estimates for the fifth quarter in a row, bearish trading has driven the stock towards all-time lows.

This is Industry Focus: Consumer Goods.

A full transcript follows the video.

This podcast was recorded on March 8, 2016.

Sean O'Reilly: We're taking our Shake Shack burgers with us to the movies on this consumer goods edition of Industry Focus.

Greetings Fools, Sean O'Reilly here at Fool headquarters in Alexandria, Va. It is March 8, 2016, and joining me to talk about the Shake Shack earnings release and a big movie merger is the incomparable Vincent Shen. What's up man?

Vincent Shen: Hey, Sean, how's it going?

O'Reilly: Not too bad. How much House of Cards have you watched?

Shen: I figured you would bring this up. I have only seen three episodes. I've not been able to binge my way through it quite yet like a lot of people have.

O'Reilly: I won't spoil anything.

Shen: Do not spoil anything for me or our listeners.

O'Reilly: OK. If you did not hear, president Frank Underwood visited us in the studio last week. You should probably go listen to the show, which occurred on Friday. Anyway, moving on. Shake Shack, everybody's ... did you read that article I wrote about them like six months ago?

Shen: OK, so I know you're ...

O'Reilly: The valuation on this company ...

I know your sense of this company and we can get to that, but they did report a pretty good fourth quarter and solid full-year results.

O'Reilly: Are you talking about their first profits since having their IPO, Vince? Is that what you're talking about? All right, what were the results?

Shen: So keep in mind, everyone, that this is the fifth quarterly earnings announcement from the company since their IPO, which was last January. And just a reminder that the company priced at about $21 per share during its IPO, and then its first day of trading it more than doubled and closed at $45.90. It's been on a pretty volatile path since then, and as I'm sure you've enjoyed a little bit, it peaked at $93 per share in May.

O'Reilly: I was about to ask you -- it peaked out somewhere crazy.

Shen: In about four months of pricing it hit over $90 ... it's basically come down. What were you saying?

O'Reilly: It was going to be the next Chipotle, Vince. Of course, it had to go to $100.

Shen: Well, even their long-term trajectory doesn't put them at that many locations -- $93 in May; now they're trading down to around $30-$40, and the thing is, investors who got in on the ground floor I'm sure were sitting back and still are enjoying pretty significant gains right now. [Crosstalk] It almost doubled, exactly. But we'll see that, especially with some insider selling that there obviously was a bubble there, so to speak.

O'Reilly: So how were comps, revenues, all that good stuff?

Shen: So getting down to the actual details of the release, the latest round of earnings, total revenue was up for the quarter about 47% to $51 million. Specifically the Shack sale, so excluding the licensing revenue they do internationally, it was up 49% to $49 million. Earnings swung, as you mentioned, from a $0.05 loss per share in the year-ago quarter to a $0.08-per-share profit. For a fifth quarter in a row, or their fifth release in a row, they bested Wall Street's top- and bottom-line forecasts, so they're five for five, batting a thousand right now.

Despite that, the stock is down about 7%, 8%, before we came down to the studio. The thing is, even beyond headline figures, I thought there was a lot to like in the press release, at least for the quarter. So same-Shack-sales growth was 11% during the holiday period. So what people would generally call same-store-sales growth, comparable-store-sales growth. And that's up from 7.2% in the year-ago period. For the full year, same-Shack-sales growth was 13.3%, pretty incredible. And that's up from just 4.1% in 2014. Tons of improvement there.

O'Reilly: It's a lot of milkshakes.

Shen: And the Shack-level operating profit just about doubled to $53 million during the year. The big thing here that I want to stress is their operating margin expanded of almost five full percentage points to 28.9%, pretty impressive. The restaurant base grew with 13 domestic and eight international Shacks opened last year. Just about a 33% increase in their system, and that includes their first Shack in Asia, open in Tokyo actually.

O'Reilly: Did you ... half these gains, like the operating margins and everything, did you know that half those gains actually came from their original location in Central Park in New York? I'm kidding, but that's what I think. 'Cause, what, they only have, like, 20-some odd locations.

Shen: No, no. Total they have about 84.

O'Reilly: Oh, wow, I'm sorry, OK.

Shen: It's split -- 30-ish or so are international and the rest are domestic.

O'Reilly: So what was the guidance, 'cause that's arguably the reason that the stock fell, because this company ... the reason people are paying this valuation is for the growth.

Shen: Well, you just heard the quarterly and the full 2015 numbers, pretty impressive. Same-Shack-sales, like, wow, but the guidance is where they're taking the hit on the chin here. So looking forward, the company is going to be entering some new markets in 2016. Big ones are, like, Los Angeles and South Korea. Again, they're thinking about 13 domestic locations for new openings and then seven of their international licensed ones, and then ...

O'Reilly: That's what I was thinking; they're going to open 20-ish stores. That's what I was thinking. OK, anyway ...

Shen: So in terms of the guidance itself, 2016 revenue is expected between $237 million and $242 million. So the midpoint there would represent about 25.7% growth over 2015, whereas 2015 saw 61% growth. So that deceleration, obviously, people are not happy about that. Same-Shack growth, I think, this is also what really people got worried, going from that 13%-plus that I mentioned earlier to between 2.5% and 3%. So that's below even 2014 levels.

O'Reilly: That 13% number you're talking about, that's Chipotle quality. Do you remember some of our first episodes a year ago? I mean, we were talking about, how does Chipotle have these ... they're already huge and they're having, like, 8% sales. It was just absurd. Then of course they had the problems that they're running into today with cilantro poisoning, but anyway. But this 2.5%, that's like ... McDonald's in a good year or something.

Shen: It's just such a stark difference from what it was able to log last year, and that, I'm sure, has a lot of people worried. The thing is, these numbers were just shy of what analysts' estimates were for 2016. So actually, in terms of the Wall Street forecast ...

O'Reilly: I wonder if they wanted them to beat their estimates ... of course they want them, but ... did they secretly want them to?

Shen: So despite the rough year trading ... the stock's still almost doubled from its IPO price. So the valuation, and I know this is where you harp on this sometimes, is high. It trades at about 5.8 times expected 2016 sales, based on that guidance, and 97 times forward earnings.

O'Reilly: I'm sorry, what was that -- 97? I plugged my ears, but I still hear that.

Shen: It's just shy of triple digits, which it enjoyed for pretty much all of 2015. It's high; I cannot deny that.

O'Reilly: I hope our audience heard my sigh there.

Shen: So keep in mind, that's a hefty premium to most other restaurants, and that includes the full spectrum ... like the traditional leaders, like McDonald's to the newer generation of, like, Chipotle, Chuy's Holdings. That's a premium to all of those guys.

O'Reilly: With burgers.

Shen: As you can imagine, at those levels, investors ... that's driven by really high growth. Either top or bottom line or both. And for them to have this outlook for 2016, things slowing down, it doesn't surprise me that the stocks trading down and that investors should be concerned or thinking about where that valuation comes into play, or where it comes back in to more reasonable levels. I think another really bearish signal for investors was, during the fourth quarter last year, even continuing through the first few months of 2016, a lot of insider selling. It seems like a lot of these bigger shareholders, kind of, they know where the stock potentially is going, and they're cashing out now. It's definitely concern.

On a positive note, I will say that the company's in a pretty strong position to invest in their global growth plans for new restaurants. They've said there's 84 stores currently, they had previously stated a goal of about 450 restaurants [crosstalk] for the system. Their cash balance jumped from less than $3 million to over $70 million last year. Definitely lots of money to put into these new locations.

O'Reilly: I wonder how much of that came from the IPO proceeds. Kind of, sort of, maybe?

My big complaint -- I wonder when did I write that article -- google "Motley Fool Sean O'Reilly Shake Shack" if you want, listeners. My big thing, as our listeners may or may not be aware, I have very simple food tastes. I have a very Midwestern palate. Vince I'm sure can ...

Shen: I give Sean a lot of grief because he, sometimes, I think, eats things a little too plain. You got to adventure out a little more.

O'Reilly: There's nothing I love more than cheeseburger and fries. I consider myself a cheeseburgers and fries connoisseur.

Shen: And do you enjoy a Shake Shack burger and fries?

O'Reilly: This is just it, shakes, amazing! Burgers, awesome! Fries, great. It's a little pricey, but it's fine. You're probably getting what you pay for. My thing is, there is no food that is more commoditized in the United States of America than burgers and fries. I can go get a burger and fries, I don't know, we can go to the Italian Deli, we can go to the Trademark bar up the road, we could go, I think of probably five places I can get a burger and fries within five minutes.

Shen: You're absolutely right.

O'Reilly: The competitive advantage that Shake Shack offers is vastly [similar to], like, a Chipotle. They seem to got the fast-casual Mexican thing going on...

Shen: Shake Shack has its brand power right now and the fact that it's very very popular. Its new location openings are known to have lines out the door and down the block. When you have that kind of consumer diner following, it definitely helps in contributing to, I'm sure, a lot of the hype with the stock price hitting $90-plus last year. There's definitely no discounting the fact that they are king of the heap right now in terms of burger world, but enough to justify where they're trading at.

O'Reilly: Do you think that like an L.A. location, which I'm glad they're doing that, 'cause that's obviously a natural jump, but do you think an L.A. location can get anywhere close to the revenues of their original location in Central Park? Because I understand that one's like ...

Shen: That's tough to call, because that has such a sordid history.

O'Reilly: It was literally a shack in Central Park.

Shen: It started as, like, a hot dog cart.

O'Reilly: Yeah.

Shen: When I lived in New York, everyone talked about a Shake Shack, and this was before the IPO. It was this New York place, this very New York-centric ... it had that feel to it. It was very, very popular. They've been able to, I think, replicate a lot of that worldwide.

O'Reilly: OK, well, before we move on, I wanted to point our listeners to the newly redesigned focus.fool.com. There you can take advantage of a discount on The Motley Fool's Stock Advisor newsletter that works out to $129 for a full two-year subscription. Once again, that is focus.fool.com.

And moving on, I'm going to prove once again how green I am. AMC is buying a theater chain that I had not heard of, and I'm really sorry. Carmike? How big are they?

Shen: I'm surprised! They're the No. 4 operator, actually.

O'Reilly: They are -- is it a West Coast thing?

Shen: I think it's moreso South-Southeast region, which actually, as we'll get to, pairs really well with AMC.

O'Reilly: Cool. Well, let's dive in. What are the details?

Shen: Sure. :ast Thursday, AMC Entertainment Holdings -- they're the No. 2 theater chain, by screen count, at least -- they announced they would be acquiring Carmike Cinemas, No. 4 chain. They're going to join up to beat out No. 1, who's currently Regal --

O'Reilly: See, I'm a Regal man.

Shen: -- to create the largest theater chain worldwide. Just so our listeners know, the No. 3 player is actually Cinemark. The CEO of AMC is pretty new. He took the reins in January. His name is Adam Aron. He came from Starwood Hotels & Resorts, and he's already making his mark. He took over, like I said, just two months ago, a little over, and apparently there were two previous attempts for AMC and Carmike to do a deal, I think it was over the past four years, but they always fell through. But he made it happen.

O'Reilly: In your research, was it a price question? Why did it fall through a couple times?

Shen: I'm not sure. I think there's some concerns that we'll get to around the deal. I think it's really driven by the new CEO and also the owners of AMC, which we'll get to. The purchase price was $30 per share, about a 20% premium to where Carmike stock closed before the announcement. Including debt assumption, the deal value comes out to about $1.1 billion. AMC, I thought this was an interesting metric, is paying about $376,000 per screen.

O'Reilly: Does that sound right?

Shen: On that note, AMC currently operates about 5,400 screens, so adding the approximately 3,000 Carmike has will give it a base of over 8,000 screens in over 600 theaters in 45 states. So, huge countrywide operation.

In terms of the deals effect on the two companies, they expect it to be accretive to cash flow right off the bat. The combined company, they think, will enjoy about $35 million in annual costs synergies, and as you'd expect, really similar operations, they're seeing that in accounting, finance, technology. They're also seeing some benefits with their negotiations. They're now the largest theater chain. They get to push their negotiations a little harder in terms of the revenue sharing with a lot of the major studios.

Investors seem pretty happy with the deal. Obviously, Carmike shares traded up closer to the offer price. AMC shares are up over 10% since announcing the deal.

O'Reilly: That's pretty rare, to see an acquirer rise.

Shen: I think a lot of people are very positive because of how complimentary their networks are. You have AMC, which is generally more focused in urban areas in the Northeast. And then you have Carmike, and maybe this is why you're not as familiar with it, is more focused on, like, rural small town, suburban areas, in the Southeast. So you put the ...

O'Reilly: I do not make it to small-town Florida.

Shen: Well, yeah, the first time I had ever seen a Carmike theater was when I was still at UVA in Charlottesville.

Like I said, AMC shares up over 10% since announcing the deal, so investors seem pretty bullish and happy. Not to say there aren't going to be some challenges and other things to keep in mind. I think it's really good here to have some background, an industry color in terms of where the theater industry ... the theater sector, or the operators have been, overall.

First of all, you got to recall that China's Dalian Wanda Group, so it's run by the richest man in China, his name is Wang Jianlin. He acquired AMC in 2012 for $2.6 billion, and since then it's been pretty clear he's trying to expand his influence over entertainment worldwide, because Wanda is already the largest theater operator worldwide -- they already own the largest theater chain in China. So this now gives him the largest theater chain in the U.S. as well. They got this nice filled out portfolio there.

They're moving really aggressively with more consolidation, so they bought, they announced a deal to acquire Legendary Entertainment a few months ago for $3.5 billion. Keep in mind AMC also acquired Starplex Cinemas last year for about $170 million. Tons of consolidation in the industry, and that's probably just because of some, like, higher-level trends, I think, with consumers in entertainment. The fact of the matter is, there's a lot of these new options, streaming services. And just taking, I think ... in terms of entertainment options from movie theaters. People have a lot of choices now on a Friday night for what they want to do.

For industry-wide, the number of screens and ticket sales have fluctuated significantly over the past decade or two, they've been stagnant or declining, too. I feel like within the U.S. these theater chains and this industry, it's like a perfect example of a saturated market. So these companies have been forced ... the only way they can achieve better scale is either through some of these consolidating deals, or they've been trying to boost their results with a lot of these new amenities. Think what's come up in the past 10, 15 years: IMAX, 3D ...

O'Reilly: Lounge chairs.

Shen: Lounge chairs, and then I see way bigger menus now, I feel like, at the concession stand. It used to be popcorn, candy, soda. Now you have also have much more substantial food. Think like wings, chicken tenders, I see fries, even, like, burgers sometimes at some of these theaters.

O'Reilly: They have bars sometimes.

Shen: Exactly. So bar service too.

O'Reilly: What ... I had known this for a while but we talked about in ... six, eight months ago when we did our original theater show. What percentage of revenues and profits for theaters comes from the concession stands? 'Cause it's, like, all their money, basically.

Shen: We mentioned the revenue-sharing deals that they have with these major studios, so the thing is, the margins that they get from their concessions, I think at least double what they get from the ticket sales.

O'Reilly: They're charging $8 for popcorn that costs 10 cents.

Shen: You can see how important that is and you can see how they've ... how they're innovating, by expanding this menu. I, personally, as a moviegoer, in terms of the viewing experience, don't necessarily appreciate when somebody walks in and it smells like fried chicken in the theater, and I can hear them eating. But at the same time I can understand that with this kind of saturated market they're pushing with these lounge chairs and these other offerings to try and boost attendance.

This deal itself, in my view, also not necessarily certain, just because there is going to be a lot of oversight and review by regulatory authorities and the fact that we now have from four to three bigger players, and just the size of it, I think a lot of investors are expecting the combined entity to have to shed some theaters in order for the deal to go through.

O'Reilly: Got it, cool. All right, well, thank you for your thoughts, Vince. Have a great day!

Shen: Thanks, Sean.

O'Reilly: If you're a loyal listener and have questions or comments we would love to hear from you. Just email us at [email protected]. Again, that is [email protected]. As always, people in this program may have interest in the stocks that they talk about, and The Motley Fool may have interest in the stocks, so don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly, thanks for listening and Fool on!