Shares of AMC Entertainment Holdings Inc. (AMC, Financial) spiked more than 15% on Wednesday following the movie chain's announcement that it plans to have 70% of its domestic locations open by Friday. Rival theater chain Cinemark Holdings Inc. (CNK, Financial) plans to have 70% of its own domestic locations open by Sept. 11, causing shares to pop 9%.
The majority of reopenings will occur around the release of highly anticipated titles such as "Tenet" and "Mulan," which is in line with the reopening plan that AMC laid out in April. As for why many theater chains did not jump on the chance to reopen their locations as soon as lockdown restrictions eased, the answer is simply that operations would have cost more money than they brought in, which would have increased their likelihood of having to file for Chapter 11. An AMC representative said the following in an April statement:
"As we plan our reopening, the health and safety of our guests and associates is our absolute highest priority. To be able to open, we also need a line of sight into a regular schedule of new theatrical blockbusters that get people truly excited about returning to their favorite movie theaters. Those blockbusters are scheduled to return this summer, beginning with Warner Bros.' Tenet and Disney's Mulan, with many more major titles scheduled immediately thereafter."
AMC stock is now down 15% year to date and 36% over the past year, while Cinemark stock is down 51% year to date and 57% over the past year, even despite the gains on the positive reopening news. Thus, as the theater chains begin to look forward to being able to turn a profit on more of their locations, could they be a potential value opportunity for investors?
Expectations on recovery
Theater chains have been some of the hardest-hit companies by the economic recession, not only because of the sudden loss of demand but also because they went into the Covid-19 crisis with high levels of debt on their balance sheets. This meant they could not afford to begin reopening until they could be relatively certain of enough customer traffic to compensate for the cost of operation.
AMC even warned investors in April that it could file for bankruptcy protection, though the company has so far managed to avoid this outcome. Back in June, Cinemark CEO Mark Zoradi warned, "The reality is, I don't think we're going to be able to get into a full-on rhythm again of product cycles and all that we had prior to COVID-19 until 2022."
According to AMC's second-quarter earnings report, the company had already reopened about a third of its locations in Europe and the Middle East, with plans to have all international locations running by the end of August.
The company plans to keep its cost-cutting measures in place, only utilizing resources that are able to have a direct and observable positive affect on income, such as bringing staff back on board only as necessary and keeping marketing and other non-essential operating expenses suspended.
Also of note is the agreement that AMC struck with Universal Studios during the quarter. With highly anticipated movie titles unable to release during most of 2020 so far, many new releases have taken the digital route, causing a round of clashes and negotiation between movie studios and theaters. For example, when Universal celebrated the success of its digital release of "Trolls World Tour" in April, CEO Jeff Shell suggested doing simultaneous digital and theater releases even after movie theaters opened their doors again. In response, AMC issued a statement that it would no longer showcase Universal films at its theaters, as these films would not be as profitable as theater-first titles.
In July, AMC backed down from its aggressive stance as the pandemic continued, and the two parties agreed to a deal allowing new movies to be released on-demand within 17 days of their debut, drastically reducing the window of exclusivity for AMC's big screens from the previous 75 to 90 days. One caveat seems to be the AMC will generate some revenue from the digital releases, as CEO Adam Aron commented during the second-quarter earnings report:
"We would be remiss not to mention the landmark agreement just signed with Universal Studios which generates revenue for AMC when consumers watch films in our theatres or when they do so on their couches at home, and we have already commenced discussions with all of our studio partners to determine their interest in our pursuing similar agreements with them."
From this arrangement, we can see that the theater industry will be permanently changed by the crisis in the same way that the work-from-home environment has been – by speeding up changes that likely would have happened in a much slower timeframe otherwise. Since a longer window between the theater release and the digital release means more marketing expenses for the studio, most studios have shown interest in making this change in the past. Coupled with the fact that most revenue from ticket sales is generated in the first few weeks after the release, we may see AMC and other theaters make similar deals with studios in the future.
Compared to AMC, Cinemark has shown less interest in making similar deals. It has also been less in the public eye with regards to its financial woes and reopening plans, which may be contributing to the stock's more severe price decline.
On the second-quarter earnings call, Zoradi outlined the company's plan to reopen a third of its locations by Aug. 21, another third by Aug. 25 and the remaining third on Aug. 28, though this optimistic goal was eventually rolled back.
When asked if Cinemark was planning to make any deals similar to the AMC-Universal bargain, Zoradi answered:
"There's no new aggressive discussions that we're in the middle of. So I would characterize it as ongoing and nothing tremendously different in the last weeks since that announcement came out, so really nothing else to say than that. It's ongoing and it has been ongoing for as long as I've been in this business. I mean, it's been ongoing for 30 years and it's going to continue to. So as I stated in the prepared remarks, we are open and active to discussions, but relative to negotiations."
By itself, the fact that Cinemark's top executive has not felt pressured to make a deal with studios in exchange for additional revenue from digital releases indicates that the company is in better financial standing than AMC. Only time will tell if the better long-term strategy is to keep screen time or make the most out of the rise of digital, even if it means potentially accelerating a decline in popularity for movie theaters.
Debt arrangements
As of Sept. 2, AMC has a cash-debt ratio of 0.05 and -$118.38 in net cash per share, while Cinemark has a cash-debt ratio of 0.16 and -$34.26 in net cash per share, both of which are significantly below the media industry's averages.
Both companies have issued substantial new debt. AMC issued $500 million of 10.5% first-lien notes due 2025 in April. More recently, on Aug. 19, Cinemark announced a $400 million convertible senior notes offering at an interest rate of 4.50%, to be due in 2025.
An interest rate of 10.5% is likely to weigh heavily on future earnings, so even as economies around the world begin to recover, AMC may find it difficult to turn enough of a profit to make interest payments as long as demand remains depressed. Even before the pandemic hit, the company had been increasing its debt for years even as cash on hand slowly declined.
With an interest rate of 4.5% on its most recent debt offering, Cinemark clearly has the better credit rating between the two companies and its borrowing will be about half as heavy as AMC's. The company's debt appears to have been growing at a faster clip, but this is only at first glance; the sudden increase in both debt and revenue during 2018 came from Cinemark's acquisition of National CineMedia, which was formerly owned by AMC.
Valuation
With new debt weighing down their balance sheets and expectations for more permanent declines in customer count, it seems too early to make a call on when theater chains will be able to create value for shareholders again. AMC's agreement with Universal indicates a concession that the demand for earlier digital releases will continue to increase, and if we see more deals like it in the future, it could indicate that there are no longer many growth opportunities in the theater industry. If the theater chains do not eventually produce more earnings than they did before the pandemic, then it could be even more difficult to create value for shareholders while prioritizing bondholders.
The below chart shows the quarterly earnings per share of AMC and Cinemark, along with estimates of future earnings per share from Morningstar analysts for the next two years. According to these numbers, analysts are expecting earnings for both companies to recover to slightly below their averages for the few years before the pandemic, with AMC's earnings predicted to remain in the negatives at least through the third quarter of 2021.
Assuming earnings per share is consistent with analyst estimates, if investors were to buy shares of Cinemark at the Sept. 2 price of around $16.08 and hold them through the next two years, the shares would trade with a price-earnings ratio of 18.06, which is about the same as its 10-year median price-earnings ratio of 18.09. It would be even longer before AMC could turn a profit, so investors would need to be taking a more long-term (and much riskier) bet on the company's success.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
Read more here:
- Top 3 New Buys of the Causeway International Value Fund
- Oakmark International Small Cap Fund Buys 4 Stocks in 2nd Quarter
- The SPAC Bubble: Buy Signal or Warning Sign?
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
