Value Investors Club / AMC ENTERTAINMENT HOLDINGS (AMC)

Description

AMC Entertainment has been written up multiple times on VIC, both as a long and more

recently as a short. People have made money both ways. I am recommending going long now.

AMC is down 28% for the year and hit an all-time low on November 13th on a confluence of

circumstantial factors which I describe below.

1) The ASC-842 accounting change reclassified $427.3 of Financial Lease Obligations from

capital leases to operating leases. The result is was a reclassification of $427.3 in

Finance Lease Obligations to Operating Leases and a reclassification of $57.6 million in

principal payments, $29.5 in interest expense, and $6.2 million in deferred rent ($93.3

million total) to EBITDA. Using Goldman’s 7.5x EBITDA multiple, the hit to AMC’s

“value” is $272.5 million or about $2 per diluted share. We believe that the full GAAP

impact to EBITDA understates AMC’s profitability given a portion of this debt and

EBITDA is truly debt and principal payments from embedded loans from landlords. The

FLOs came about primarily from build to suit net leases acquired with the Carmike (U.S.)

and Odeon (U.K.) acquisitions.

2) A weak first quarter box office that was comparing to the strongest Q1 in history,

exacerbated an EBITDA already down 10% from ASC-842. Reported Q1 EBITDA was

$108 million compared to $278 million in 2018. $23.7 million of this decline was due to

the aforementioned ASC-842 accounting change and $146 million was due to the weak

box office (-15.6% YoY, the largest QoQ decline in Box office since Q2 2001). Perception

of the cinema business seems to get penalized for weak box office but rarely benefits

from strong box office. Q2 and Q3 EBITDA (adjusted for ASC-832) were up 7.3% and

31.3% on domestic box office that was -3.5% and +2.6% respectively.

3) Streaming Wars. The narrative that the VOD streaming trend will turn movie theaters in

cricket listening chambers continues unabated despite generally strong box office

performance in three out of the last four years. Wednesday’s sharp decline in AMC’s

stock price amidst euphoria for Disney+ is exhibit one. AMC declining more than either

Netflix or Lionsgate (both direct streaming competitors) is exhibit two. I am not a

believer that the cinema is a buggy whip. You don’t go on a first date to someone’s

living room (New Yorkers on Tinder aside). You don’t have the same experience in an

action film, no matter how sophisticated your home theater. Date night with your

spouse is not the same in your bonus room. I will grant that the threshold to leave the

home has risen but innovative exhibitors like AMC have risen to challenge and are

providing a more compelling product (recliners, better food (although it could still be

better), alcohol, reserved seating, subscription services, and eventually yield pricing).

Box office bears this out. 2018 was a record year at the box office. Q2 and Q3 2019

were the second highest grossing Q2 and Q3’s ever. Q4 looks to be close to a

penultimate finish as well. As a result, despite a very weak Q1, all of 2019 should be the

second highest grossing box office year in history.

4) There is a reset on the $600 million convert Silver Lake (SL) purchased in September of

2018. The original conversion price is $18.95 which would give SL a 23.1% fully diluted

stake in AMC. Through September of 2020, the conversion price does not step down as

long as AMC dividends are equal to or less than 20c per quarter (10c after September

2020). However, on September 14, 2020, there will be a 10 day look back and the

conversion price will be reset to the lower of $18.95 or 120% of the average price for

that 10-day period with a limit that SL’s 23.1% stake cannot grow to more than 30% fully

diluted. At current prices (and prices up $11.23), this would amount to a $13.48

conversion price and 13.35 million additional shares being issued to SL. Mitigating this

issue somewhat (in addition to the 30% cap) is another provision that Wanda, AMC’s

controlling shareholder, is subject to forfeiting up to 5.666 million shares should a reset

occur. So…the maximum net dilution is actually 7.69 million shares. But this should be

in the stock price at this point. The dilution can no longer get worse, it can only get

better; also, none of the new stock is coming to market.

Rather than worry about the convert, we believe the convert reset is an opportunity as it puts

pressure on the controlling shareholder and the board to pursue actions to create value. They

have ten months from now to do so; and there are a number of paths, some building on each

other which would help rerate the stock.

1) AMC could partially address the ASC-842 earnings dilution by restructuring the FLO

leases by refinancing with debt. I don’t think we have enough information to predict

the impact that such a refinancing/restructuring would achieve, but it should be

considerable. The pickup in EBITDA would likely be between $50- $100 million at the

cost of $200-$500 million in debt.

2) AMC’s previously planned IPO for its European unit could be relaunched. We would

note that AMC is further along in its capital program with Odeon and Nordic,

performance has improved, and International accounting standards do not treat FLOs

(most of AMC’s FLOs originate from Odeon) as rent, and so Ode0n would present a

higher EBITDA contribution as a stand-alone than it does for the consolidated company.

The proceeds could be used to pay down debt and/or repurchase stock.

3) AMC’s previous $100 million share repurchase program expired in August with $56

million of stock purchased at 14.87, a 69% premium to the current stock price. AMC

could reinstate a new share repurchase authorization funded by its lower cap ex plans

going forward and/or the aforementioned IPO of the European business. We would

note that AMC’s float is only $460 million and 41% of the float is short. A $50 to $100

million share repurchase would have a significant impact.

4) Free Cash Flow is about to improve. AMC is guiding to $300 million of cap ex ($150

million of maintenance cap ex) for 2020 versus $415 in 2019. We also expect EBITDA to continue to grow.

5) AMC’s fleet of theaters should grow. Currently, AMC has about 3% of its screens offline

for refurbishment. Given the lower growth cap ex going forward, the number of off-line

screens should decline, giving a boost to revenue and profits at a much higher rate than the #

of sceens would imply given the fixed cost nature of the business.

6) AMC’s new market in Saudi Arabia is showing huge success, with the first theater in

Riyadh generating 11x the revenue per screen as a typical theater in the U.S. Saudi Arabia and

AMC have aggressive plans to open additional theaters with Saudi providing the Capex and the

next theater opeing in December 2019

7) Q4 2019 box office should be strong with Ford vs. Ferrari opening this weekend, Frozen

2 opening November 22, a new Jumanji movie opening December 13, and the last Star

Wars movie and Cats opening December 20th.

8) Q1 2020 Box office should be respectable as well from overflow from Star Wars and Cats

into January, a new Robert Downey Jr movie (Dolittle), a new King’s Man movie, a Jim

Carrey Sonic the Hedgehog movie, Godzilla vs Kong, a Pixar release Onward, and a live

action Mulan (opening late in March). Q1 2020 has a very comparison to Q1 2019.

9) Q2 2020 Box office will see all of Mulan’s box office after its opening weekend, an as yet

unannounced DC Comics movie, The Marvel Universe’s Black Widow, Wonder Woman

1984, another Pixar release, Soul, and a Top Gun sequel with what looks like amazing

flight sequences that must be seen in a theater.

10) Faced with the coming Convert reset and the potential to lose 5.666 million shares,

AMC’s controlling shareholder, Wanda may decide its best solution is to sell the

company.

11) Finally, AMC’s profitability is structurally higher than the market believes. Q1 2019 was

a disaster. EBITDA came in at $108MM which adjusted for ASC-846 compares at around

$130MM to $278MM in Q1 2018MM, $251MM in Q1 2017, and $146MM in Q1 2016

when AMC didn’t even own Carmike, Odeon, Nordic and had not made probably half

the recliner investments it has to date. Understanding that Q1 was an anomaly (i.e. it

could have been $100MM-$125MM higher), that ASC-846 understates EBITDA by at least

$50MM, and that that fewer screens will be out of operation next year than this year

($25 million contribution). AMC’s true EBITDA run-rate for 2020 could be closer to $975

million than the $800 million that the street is expecting.

Risks

Box Office

Box Office is inherent unpredictable. Release schedules are not organized to smooth out

exhibitor revenues. And whether a film is well received or not has as much to do with audience

moods as the success of the creative process.

Operating Leverage

Cinema is a fixed cost business with significant operating leverage. Profitability can surge or

crash in any given period based on the quality of the film slate. Theaters chain operators can

react at the margins, but as evidenced by Q1 2019 when EBITDA dropped >60%, it is important

to keep the seats filled.

Debt

AMC is highly levered. 5.6x per my math. Its understandable given the opportunity they saw in

acquiring Carmike, Odeon, and Nordic. However, long term it is too much. Happily, AMC

management agrees (or at least they say they do). AMC’s debt does not mature until 2024, so

it not an issue today.

Economic Cycle

Many industry observers argue that Cinema is recession proof and cite box office growth of 4%

and 12% in 2008 and 2009. However 2001 box office was down 5.1% and 1994 box office was

down a whopping 24.6%. We believe a recession would certainly heighten the risk as going to

the movies has become a more upscale experience over time.

Valuation

Our Estimate for 2020 EBITDA is much higher than the street. while the street is at around $800MM and a 7.5x EV/EBITDA valuation, we are at $900MM and a 6.7x EV/EBITDA valuation. Our Price target at 8x $900MM of 2020 EBITDA is $17-$18 depending on the outcome of the reset. We point to the high cash generation which it currently masked by the intense investment cap ex cycle the company is pursuing. From $900M of EBITDA for 2020, -$350 of Interest Expense and -$150MM of maintenance cap ex, free cash flow before growth cap ex should be around $400 million; or a 30% free cash flow yield to the fully diluted/reset equity. Before growth cap the dividend payout ratio is around 20%. After growth cap ex, the dividend pay-out ratio is around 33%; with >$150 MM available to paydown debt/annually.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Catalysts

Strong Box office from Frozen 2 and Stars Wars the Rise of Skywalker

No lasting effect from launch of Disney+ on box office.

Restructuring of Finance Lease Obligations

European IPO

Stock Repurchase program

Wanda exiting through a sale of the company.

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			2019	2020
Price:	8.80	EPS	0	0
Shares Out. (in M):	142	P/E	0	0
Market Cap (in $M):	1,256	P/FCF	0	0
Net Debt (in $M):	4,731	EBIT	0	0
TEV (in $M):	5,987	TEV/EBIT	0	0