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Cineplex (TSX:CGX:CA), (OTCPK:CPXGF), the largest movie theater chain in Canada, recently reported its second consecutive profitable quarter, after numerous months of COVID related government mandated closures or capacity reductions. Specifically, the company reported diluted EPS of $0.43 in Q3 ended September 30, 2022, after reporting $0.02 in the second quarter ending June 30, 2022.
In addition to operating movie theaters, the company operates other businesses, including location based entertainment venues, that are competitors of Dave & Buster’s (PLAY), and its Player One Entertainment Group brand. The latter sells location-based video and virtual reality games and prize redemption games. Cineplex recently reported record quarterly EBITDA for the two business segments referred to in this paragraph. The company also operates a media business which sells advertising, including ad shown prior to movies.
Despite two consecutive quarters of profitability, and record quarters in two segments, Cineplex stock closed at $10.22 Canadian per share on November 29, 2022. This compares to a closing price of $24.01 in 2019, immediately before a takeover offer from movie theater chain Cineworld. The Cineworld deal never closed as Cineworld backed out of the deal it made prior to the COVID-19 Pandemic. Cineworld lost related litigation, and subsequently filed for bankruptcy in the USA, staying Cineplex’s proceedings against it.
As the stock is trading at less than half of the value of its 2019 pre-takeover offer price, I will focus on potential reasons that the stock has not recovered to those levels.
Reasons that the stock has not performed well may include:
- Stricter Canadian restrictions related to the Omicron COVID variant negatively impacted Canadian movie theaters at a time that U.S. theaters did not face similar restrictions. This certainly did not help Cineplex’s return to profitability.
- Investors may fear the impact of a potential recession on Cineplex sales.
- Some investors may believe that streaming services have reduced demand for movie theater attendance.
- Investors may not have considered that Cineplex has business areas beyond movie theaters that may provide future growth.
- Investors may not be considering that Cineplex differs significantly from its U.S. counterparts.
I will examine each of the above potential concerns below.
1. Impacts of COVID on Theater Attendance and Film Production
Late 2021/Early 2022 Strict Canadian Omicron Restrictions Adversely Impacted Cineplex
In November 2021, I wrote that Cineplex appeared undervalued. I noted then that “absent a new COVID variant” public confidence to attend movie theaters may have hopefully increased in Canada.
Unfortunately, shortly after my article, the Omicron variant emerged. As a result, before the end of December 2021, governments in provinces across Canada had shut down movie theaters.
Canada’s most populous province announced on December 15, 2021 that theaters with capacity over 1,000 patrons would see capacity cut in half. Weeks later, the Ontario government ordered all cinemas be closed on January 5, 2022. The province also forced restaurants to close indoor dining on that date, negatively impacting Cineplex’s Rec Room and Playdium chains.
Perhaps these closures and capacity restrictions are a reason why that over the past year, Cineplex stock has declined from the $13.28 close on November 22, 2021 to current levels in the $10 range. (All values in this article are in Canadian dollars, unless otherwise indicated, and all references to Cineplex stock are to the shares that trade on the Toronto stock exchange. Investors interested in the over-the-counter US trading shares are reminded to evaluate the risks of such shares).
As a result of Omicron closures, Cineplex was unable to maximize revenues from major blockbuster releases during that period, such as Spider-Man: No Way Home, released on December 15, 2021, and grossing almost $2 billion worldwide, and $805 million domestically (defined as the USA and Canada within the movie industry).
As Cineplex CEO Ellis Jacob has stated that Cineplex typically accounts for 7 to 8 percent of the North American box office, it’s easy to see how just one movie during a lockdown may have accounted for lost revenue of over $50 million.
It is impossible to predict if another COVID variant or other virus will result in future lockdowns in Canada. However, unlike last year, Canadians have access to updated bivalent vaccines and vulnerable Canadians may be able to be prescribed the COVID-antiviral pill Paxlovid. Further CBC reported in September that an estimated 70 to 80 percent of younger Canadians contracted COVID in the summer. While COVID is not over, younger people who have recovered from the virus may view attending entertainment venues as less risky than in prior stages of the pandemic.
This willingness to attend Cineplex venues is supported in part by the fact that Cineplex reported 11.1 million theater patrons in the third quarter of 2022, an increase of 34 percent compared to the comparable prior year quarter. This is still about 37 percent less than pre-COVID, Q3 2019 attendance of 17.5 million, and Q3 2018 attendance of 17.2 million.
However, Ellis Jacob noted in its most recent quarterly conference call that:
“In fact, revenues for comparable LBE [location based entertainment] locations reached 95% of 2019 levels, with many locations exceeding 2019 results.”
In other words, the box office attendance in the most recent quarter relative to 2019 levels, does not appear to be significantly COVID-related, as attendance is a robust at the LBE venues, where people are obviously in close proximity with others whether dining or playing games.
Impact of COVID on Film Production
Rather, as explained by management, and expected by analysts, the recent quarter had fewer new releases. Specifically, according to Box Office Mojo, 186 movies were released in Q3 2022, compared to 342 in the same quarter of 2019.
A 37 percent box office attendance decline relative to 2019 appears to be better explained by a 45 percent decline of movies released. This was not unexpected as it has been widely reported that movie studios have experienced COVID delays in production, impacting the most recent quarter.
2. Fears of a Recession
In Cineplex’s most recent quarterly earnings conference call, CFO, Gord Nelson addressed this concern with an unsurprising statistic:
“In fact, during seven of the last nine recessionary periods, box office revenues have increased.”
Obviously, people want an affordable option to distract themselves during recessions. Cineplex reported box office revenues per patron (BPP) of $11.25, and concession revenues per patron (CPP) of $8.35. These metrics were slightly down compared to the prior year comparable quarter. The company attributed these declines of 1.1 percent for BPP and 2.7 percent for CPP to discounts given on the industry-wide National Cinema Day, which occurred in the quarter.
I will note that while the media has recently pointed out that Walmart (WMT) stock fares well in recessions, yet investors seem unfocussed on Cineplex stock. An increase in box office revenues in seven out of nine recessions may be a great reason for investors to consider Cineplex as a stock if they believe there will be a downturn.
That said, Statistics Canada, a Canadian federal government agency, announced on November 29, 2022, that Canadian GDP rose 0.7 percent in the third quarter.
I will leave it to readers to make their own determinations as to whether Canada may be headed for a recession, but reiterate that if it does, historically movie theaters have done well more often than not.
Having said that, some investors may believe that this recession is different, as cinemas are competing with streaming services, so I will next discuss that concern.
3. Will streaming services decimate theater attendance?
Cineplex stated in its conference call that it is working with streamers, including Netflix (NFLX). The Netflix film, Glass Onion: A Knives Out Mystery, is currently playing in Cineplex theaters. Cineplex pointed out, and I strongly agree, that putting a movie in a cinema helps promote that movie for when it becomes available on a streaming service.
Movie theaters offer something streaming cannot: a shared communal experience with a group of strangers. I would argue that this lack of shared experience has extended to television, where cord-cutting results in people streaming TV shows on different services at their own pace. This has eliminated the traditional water cooler experience of discussing what happened on any popular linear television series the night before.
I believe people want these shared experiences in movie theaters, and at today’s equivalent of the office water cooler: on social media and via messaging.
Word of mouth may be difficult to convince someone to watch seven seasons of a series that a colleague suggests “gets good after season 3”. However word of mouth recommending a ninety minute movie may be more effective advertising than scrolling through algorithm-recommended film titles that viewers know nothing about on a streaming service.
If this was not the case, why is Netflix releasing films in Cineplex theaters? I will add that movie trailers shown as commercials during live sports and news programs further raise awareness of viewers of the advertised films, in a cord-cutting era.
Further, as society has often associated direct-to-video content as inferior to theatrical releases, associating a movie with a big screen may increase excitement about a film title, even if it is ultimately watched on a streaming service. This is good for cinemas, as it gives an incentive to show movies there with a significant window prior to streaming.
4. Cineplex’s Other Business Segments Achieve Record Quarterly Results and Sum Of Those Parts
As mentioned above, Cineplex had two business segments achieve record quarterly earnings in the most recent ended quarter of September 30, 2022. They are:
Player One Amusement Group. This seller of carnival-esque and other fun games earned record third quarter revenues of $45.5 million on the quarter. This represents a 28 percent growth rate over the same prior year quarter.
Location Based Entertainment (LBE): Under brand names including the Playdium and the Rec Room, these venues, which are competitors of Dave & Buster’s, earned all-time record quarterly revenues of $31.0 million on the quarter. This represents a 42 percent growth rate over the same prior year quarter.
These announced growth rates may be higher than under normal circumstances due to negative lockdown impacts of COVID in the prior year comparable quarter. So I will look at these numbers compared to the pre-COVID third quarter of 2019.
|
Business Segment |
Q3 2019 Revenue |
Q3 2022 Revenue |
Growth Rate From Q3 2019 To Q3 2022 |
|
Player One Amusement Group |
$44.8 million |
$45.5 million |
1.6% |
|
Location Based Entertainment |
$19.6 million |
$31.0 million |
58.2% |
It is promising that these two segments had growth since the comparable period in 2019. Location Based Entertainment has especially experienced a noteworthy growth rate, considering that these venues were subject to closures or reduced capacity for much of 2020-2021.
Potential Sum of the Parts Of Just Two Cineplex Businesses
If we annualized the Q3 2022 revenues for the above two segments, those two businesses alone would have revenues of $306 million.
Dave & Buster’s has a price to sales ratio of 1.19. International Game Technology (IGT), which sells casino gaming machines (which is somewhat similar to selling entertainment machines that allow collecting credits to trade for prizes), has a price to sales ratio of 1.16.
If we gave these two Cineplex business segments a similar price-to-sales ratio of 1.16, these two businesses alone would have a market capitalization of $355 million. This compares to a market capitalization for Cineplex of about $650 million at the time or writing.
A sum of the parts valuation is notable, as Cineworld reportedly wanted to sell off Cineplex’s advertising and location based entertainment businesses if its takeover transaction closed.
I note that I am discussing the sum of the parts to demonstrate that the company is undervalued. I do not think Cineplex should be broken up, as its businesses are complimentary to each other. This is especially evident as Cineplex is launching an entertainment destination called Junxion, at multiple locations, which incorporates theaters, dining, games, and live entertainment.
Cineplex Stake In SCENE Rewards Program
While I am mentioning sum-of-the-parts analysis, a 2020 sale of part of Cineplex’s stake in SCENE, a rewards loyalty program, contributed significantly to the most recent quarter, as mentioned by CFO Gord Nelson during the conference call:
“During the third quarter, we recognized a gain related to the 2020 sale of one-third of our 50% interest in Scene LP as specified nonfinancial milestones were met. As such, we are reflecting a gain of $50.1 million in the Q3 financial statements.”
Cineplex reports that SCENE is the largest Canadian entertainment loyalty program. The math in the previous paragraph is based on the recognition of a gain from the sale of one-sixth of SCENE. For simplicity, I will assume the original value of SCENE was zero. If one sixth of SCENE is worth $50 million, that could value the program at $300 million. As Cineplex owns one-third of SCENE, that stake in the joint venture could be worth $100 million.
I have previously written about the significant value of rewards programs on this website with respect to American Airlines’ (AAL) Aadvantage program. In that article, I quoted an American Airlines conference call in which its awards program was expected to add $800 million in pre-tax income by the year 2018.
Cineplex’s 33.3 percent stake in the SCENE loyalty program has similarities to an airline rewards program. Specifically, the SCENE joint venture is owned in part by the Bank of Nova Scotia (BNS), who issues credit cards that allow for points to be accumulated for rewards including Cineplex experiences.
If we value Cineplex’s stake in SCENE at $100 million, and its two businesses above at $355 million, those assets total $455 million.
Cineplex’s Media Business
Cineplex also owns a media advertising business that includes in-theater advertising, and digital advertising in shopping centers.
In the third quarter, Cineplex recorded media revenues of $25.2 million, which increased 79.4 percent over the prior year period. This is still lower than the same quarter in 2019, where media revenues were $43.3 million.
That said if Cineplex were able to return to 2019 levels, that would equate to over $173 million annualized revenue. If we compare that to Omnicon Group (OMC), which has a current price-to-sales ratio of 1.15, that would value Cineplex’s media business at $199 million dollars.
If we added this to the above assets, the total would be $666 million, if investors agree with the above assumptions, as summarized below:
- Player One Amusement Group and LBE: $355 million
- Scene: $100 million
- Media: $199 million
- Total: $654 million
This means that at the time of writing, the value of these non-cinema businesses owned by Cineplex is close to the entire market valuation of Cineplex, which is approximately $650 million.
This is my favourite kind of investing situation, not because I want the sum-of-the-parts to be broken up. Rather, the sum-of-the-parts suggests that investors, by getting those assets, may, in theory, be getting the entire movie theater chain for next to nothing.
The above statement depends on whether you believe advertising revenue will eventually return to or exceed 2019 levels, and agree with other assumptions made above.
Given the market may not be considering the valuation of the businesses discussed above, I will now further discuss the company’s theater business.
5. Cineplex is Dominant In Canada and Avoided Problems Faced By US Cinema Operators
Cineplex reported in its Q2 2022 investor presentation that it has a 75 percent box office market share in Canada.
In contrast, AMC Theaters (AMC) boasts on its investor relations site, that it is the number one or two chain in the top 15 markets in the United States. Obviously AMC faces major competition in many markets.
During COVID, Cineplex did not significantly dilute its shares since the COVID pandemic began. In Q3 2019, the company reported 63.33 million shares outstanding. This compares to 63.36 million shares outstanding reported at the end of the same quarter in 2022, which is almost flat compared to 2019. This contrasts to significant share dilution at AMC.
Cineplex’s long-term reported debt increased from $649 million in Q3 2019 to $825 million in Q3 2022, a 27 percent increase. As a result, its reported interest expense increased from $18.3 million to $32.2 million over that three-year period. This works out to $0.51 per share in interest in the most recent quarter. Including this interest, the company earned $0.43 per diluted share.
How Much Can Cineplex Earn?
In 2018, Cineplex earned $1.35 from continuing operations, which declined to $0.58 in 2019.
As mentioned above, Cineplex interest increased from $18.3 million in 2019 to $32.2 million in the most recent quarter. This additional $13.9 million of interest works out to $0.22 a share based on current shares outstanding.
It is difficult to compare 2019 to the present, because as outlined above, Cineplex has non-cinema businesses that are growing revenues.
That said, it is not unreasonable to think that given the upcoming movie release slate which includes Avatar 2, a sequel to the highest global box office hit of all-time, that Cineplex can beat 2019 attendance and revenue numbers in the current quarter. As mentioned above, some of Cineplex’s LBE venues beat 2019 Q3 revenues in 2022 Q3.
Even ignoring cash taxes (which Cineplex has said in its conference call we should expect to be minimal over the next two years), if the company can make 2018 numbers, that is $1.13 per share in earnings, if we ignore cash taxes, for a back-of-the-napkin calculation. At an average market multiple of 15 times earrings, that would value Cineplex at $16.95, representing a 65 percent increase over current values.
All of this said, the company has been profitable for two consecutive quarters, including during a weak Q3 movie slate due to COVID production delays. At the time of writing, November 2022 domestic box office revenues are about 60 percent of 2017-2019. That said, if we look at July 2022 vs. July 2019, we can see revenues are approaching 2019 levels ($1.1 billion in 2022 versus $1.3 billion in 2019).
Based on the recently reported quarter, there may be room for this company to grow as:
- Two of Cineplex’s major business segments are reporting all-time record revenues;
- Its SCENE program stake may be worth $100 million+;
- Domestic box office numbers have shown that when desirable content is released, that box office revenues in the month of July 2019 and July 2022 both exceeded one billion dollars;
- Media advertising revenue has historically been better than it is now. Although, obviously a recession would adversely influence advertising revenue.
Conclusion
As the company has reported two consecutive profitable quarters, investors may want to consider that Cineplex has market share dominance greater than any American cinema operator. Cineplex is a potential recession – resistant business based on historical cinema revenues.
Cineplex has diversified its business by expanding into other growing entertainment businesses beyond cinema screens. It is surprising that before a potential recession, in which the world historically increases cinema entertainment spending, that this entertainment company is going unnoticed.
If Cineplex was an average company, and attained its 2018 earnings, it could represent a 65 percent gain from here. The company could potentially get to that level, given its other valuable, fast growing parts.
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