AMC’s stock (AMC) has had a rough two years. Since reaching a high of $35.60 in December of 2016, it reached a low of $12 in July 2018 and closed on Monday March 4, 2019, at $15.50, the day after reporting its Q4 2018 operating results. The theater industry remains a popular short in the investment community. As of March 1, 2019, 20% of AMC’s public float was sold short. A popular thesis behind the short is that the movie theater industry is a melting ice cube that will be destroyed by Netflix (NFLX) or other streaming/vod services. Another thesis is that the company’s subscription services, A-List, cannibalizes the company’s normal ticket sales and will fail like Movie Pass. A final leg of the short thesis driving AMC’s weakness in particular is its leveraged balance sheet, a legacy stemming from an LBO, the acquisition of several movie theater chains in 2016-17 and most recently a leveraged recap. I believe that all of these issues are incorrect or way overblown and that AMC could recover 50% in the next several months. Better yet, investors will clip a 5% dividend yield while they wait.
Debunking the Shorts/Bears:
Theaters are NOT a melting ice cube.
I wrote about Regal Cinemas in June of 2017. In it I addressed the concept of theaters being a declining business. It wasn’t the case then and it isn’t the case now. If you look at the table below, you will see that 2018 was the best box office year ever. Name another “declining” industry coming off its best revenue year ever.
Bears like to point out the downtrend in attendance to which I respond, so what? Since 2010, attendance has largely bounced around 1.3 billion annually. Some years are better, some are worse, depending on the movie slate. The one constant up trend though is average ticket price which is up from $7.89 in 2010 to $9.11 in 2018 which equals 15.5%.
Moreover, ticket sales are not the entire picture for theaters in the US. While direct ticket sales represent about 60% of revenues and concessions (popcorn, etc.) account for 30%, the gross profit dollars for the two revenue streams are very close. That’s because ticket sales are 49.5% margin (because of splits with movie studios). Concessions, on the other hand, are almost 85% margin. Average concessions per patron grow annually as well and finished at $5.17 per patron for AMC in 2018. The numbers are slightly different in Europe which I will get to.
More importantly, the data in the table above represents data from the entire US industry. AMC actually outperformed the US industry in attendance with 6.9% versus the industry’s 3.5%. AMC also outperformed in the European markets where it competes. Ticket prices in the US were slightly down versus the industry’s average growth due to the wildly successful A-List program. This takes me to debunking the next short/bear thesis.
A-List is a strong value creator
A-List is AMC’s monthly subscription business and part of its STUBS loyalty program. It was started on June 20, 2018. Subscribers pay between $19.95 and $23.95 per month (depending on the market). A-List members are permitted to “see movies at AMC up to three times per week including multiple movies per day and repeat visits to already seen movies” (from page 86 of the company’s 10-K).
The bear thesis on this program is that giving people access to 3 movies per week (12 per month) will destroy average ticket sales as A-List subscribers normally would have paid full fare for those 12 monthly movies. AMC would actually lose huge in this situation because it has to pay studios its 50% split as if it collects full fare ($9+) but it is only collecting $2. Moreover, there will be no incremental concession revenue since how many huge buckets of popcorn can someone eat?
Not only are these conclusions contradicted by the data, they miss other crucial revenue sources. On the cannibalization, perhaps there are some people who have the time to go to the movies 12 times per month. For A-Listers on average, that isn’t the case.
Straight from the Q4 2018 conference call usage,
starts out high in the first week or two of membership, settles down almost immediately to an average of about 3.3 visits per month in the first full calendar month of enrollment and quickly falls below three visits by the third month of enrollment… …In January and February of 2019, average frequency for the entire membership was already down to 2.8 visits per month. Of crucial importance in all this frequency data, our reviews suggest that the incrementality of this moviegoing is huge. Prior to joining A-List, A-List members on average were seeing only about a half a dozen or so movies per year.”
That last highlighted point is huge. The average A-List member was only seeing 1 movie every 2 months! People point out attendance declines. This program is reversing that. The company might be doing so at a slightly lower ticket price, but we are still talking incremental dollars. Moreover, these people are not going to the movies alone. They are bringing other people at full price.
Most importantly, the company is spending on concessions. Again from the conference call “So far, the average A-List member appears to increase their monthly food and beverage spend at AMC by approximately 2.5x versus before they signed up for A-List.” In other words, whatever gross margin dollars the company might be giving up in ticket sales to A-List subs, they are more than making up for it up in concession gross margin dollars.
AMC initially thought it would sign up 500,000 subscribers in the first year and the program would be profitable some time in 2020. As of the Q4 2018 conference call, 8 months into the program, the company is at 704,000 subscribers and say it was profitable in January and February. Demand is good enough that it raised prices 13% in January. Far from a money loser, management said it would not be surprised to see $3 per month of incremental EBITDA per A-List subscriber by the end of 2019. If sign-ups continue anywhere near current pace, they could finish the year at 1.5mm subs. That would mean $45 million of incremental EBITDA ($3 x 1.5mm) through the rest of 2019 – close to 5% organic growth of 2018’s $929 million of EBITDA. This incremental EBITDA helps to settle the next bear thesis: leverage.
There is too much leverage.
As a former bond trader, I frequently find it quite amusing to hear equity analysts wringing their hands over a company’s leverage, particularly when their concern is not shared by the bond market. It is true that AMC has more leverage at 5x EBITDA than a comp like Cinemark (CNK) at 2x, but so what? RGC was about 3x leveraged when it was acquired by Cineworld, which is just under 4x leveraged now. The relative steadiness of cash flows allows for leverage and all of AMC’s credit metrics are fine.
- The company has over $500mm of liquidity: $324mm of cash and $225mm revolver
- The company has no bond maturities before 2022
- EBITDA covers interest payments by over 3x.
- Free cash flow before growth cap expenditures is over 5% of debt.
Perhaps these metrics are why AMC’s 2025 maturity subordinated bonds trade at around 7% yield. Perhaps that is also why Silver Lake, a very sophisticated and successful private equity firm, accepted a 2.95% interest rate on convertible bonds that have a $18.95 ($20.50 before a $1.55 special dividend) conversion price in September. Moreover, the Silver Lake transaction allowed the company to buy back 24.1mm shares from Dalian Wanda at $17.50. Not only was this accretive to shareholders (sell shares at $20.50 and repurchase them at $17.50), the transactions actually increase cash flow. The difference between the cost of the bonds from Silver Lake and the savings from the dividends they don’t have to pay on the repurchased shares is about $1.5 million in cash annually in the company’s favor.
The number of pure play movie theaters is dwindling following the acquisition of Carmike (by AMC) and Regal (by Cineworld). CNK and AMC are both at the low end of their historical valuation ranges of 7x to 10.5x EBITDA. I find these valuations odd given the overall health of the world movie theater industry (both CNK and AMC have US and international operations), healthy film slate for 2019 and the fact that RGC was just acquired for cash a year ago (March of 2018) at 11.25x EBITDA.
$1.95bln market cap (using 126 million shares at $15.50) + $4.7bln debt + $500mm capital leases – $324mm cash
= $6.912 billion Enterprise Value
$929mm 2018 adjusted EBITDA = 7.4x
$300mm 2018 adjusted Free Cash Flow (backing out growth cap ex and landlord contributions and using $125mm of maintenance cost) = 15.4% yield
I think it is appropriate to back out growth cap ex from free cash flow since the money invested there is such high return. On the conference call, the company disclosed that theater renovations, the primary growth spend, are exceeding 25% cash on cash returns in the US and over 50% in Europe. In addition, the company guided to longer-term capital expenditures for the first time in the Q4 2018 conference call. It expects spending to decline from $450mm annually presently to $250-300mm over the 3-5 year time frame. Assuming 30% returns on its growth spend ($100mm+ incremental cash returns), true free cash after all capital expenditure (including maintenance) could well exceed 2018’s adjusted $300mm in the next few years.
As with any business, there are some risks associated with this story.
- The turnaround in Europe could falter. European underperformance hurt results in early 2018.
- A-List subscriptions could slow down, stop or start declining. There is no indication of that but anything is possible.
- The 2019 movie slate could be really bad and movie attendance could fall off. Movie slates are cyclical although the outlook is generally good for this year.
I do not find the bear/short theses on AMC to be materially different than they were for RGC. The first one, theaters are going away, is easily debunked. The leverage question is also not a concern for me at all given overall stability of the business and its ability to generate cash. Lastly, I think A-List, instead of cannibalizing the business is proving to attract incremental visits and cash flow. I think AMC is at a very attractive valuation from both a multiple of EBITDA and free cash flow yield perspective. It is at the low end of its historical range of valuation. I suppose that it could go below that range and 1 turn of EBITDA lower would result in a 50% lower stock price, but that would bring free cash flow yield to well above 20%. I think a turn of EBITDA multiple higher is far more likely (in addition to higher EBITDA for 2019) which would mean a 50% gain in the stock. Better yet, you get paid over 5% in dividends in any event.
Disclosure:I am/we are long AMC.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.