Value Investors Club / AMC ENTERTAINMENT HOLDINGS (AMC)

Description

Bottom line:

From AMC’s current price of $14, we see upside potential of 125% to our $31.44 estimate of fair value, not including the annual dividend yield of 5.7% at $14. Our estimated minimum fair value of $31.44 is based on an EV/EBITDA multiple of 9.5x estimated 2018 EBITDA of $900M (17% EBITDA margin on $5.3B sales), which results in an EV of $8.55B, minus $4.7B net debt, plus $206M in National CineMedia (NCMI, $6.90) shares and other investments equals $4.056B equity value, divided by 129.012M shares. This also equates to a market cap / FCF multiple of 11.6x estimated $350M in free cash flow for 2018.

Background:

AMC was written up by Trive25 on 6/2/17 and JSTC on 6/9/17 (JSTC posted an exit recommendation on 12/19/17). Both write-ups and discussions that followed are worth a read.

Our initial position in AMC shares came to us on 12/22/16 as partial consideration (in addition to mostly cash) for AMC’s acquisition of our Carmike Cinemas (CKEC) shares, realizing an excellent rate of return on a position that we had held for roughly nine years. Eventually adopting a rare activist stance (see our 5/16/16 CKEC write-up here on VIC), we argued that the original deal for AMC to buy CKEC at $30 per share in cash was too low, and we were partially successful in getting the terms improved to $33.06 in cash or a stock/cash combo that amounted to $34.35 in value per CKEC share on the deal closing date of 12/22/16. AMC was $35.10 and about one-third of our CKEC position converted to AMC stock. Alas, given AMC’s subsequent stock price performance in 2017, we would have been better off accepting the original all-cash offer. That said, AMC’s lower than expected earnings and share price in 2017 gave us the opportunity to build up the position in size at very attractive prices such that the longer term payoff should prove much more impactful to us than this decline. As shareholders of Carmike, we endured similarly violent stock price swings, as investors (and analysts) inexplicably continued to reprice the shares based on the most recent quarter or two, or even year, and extrapolate that performance into the future. Last year’s 2.7% box office drop, coupled with Wanda’s (the controlling shareholder) leverage concerns, the emergence of MoviePass and the fear of premium video on demand, resulted in AMC declining from a high of $35 in December 2016 to a low of $11 in November 2017. Finally, contrary to the belief of many, we feel that the box office is recession-proof. People go to movies, regardless of the economy, proven most recently by the box office hitting a (then) record during 2008’s Great Recession.

AMC’s acquisition of Carmike, the 4th largest theater chain in the U.S., made AMC the #1 player in the U.S. AMC’s nearly simultaneous acquisition of London-based Odeon-UCI made AMC the #1 operator in Europe. All told, they are the largest movie exhibition company in the world with more than 1,000 theaters and 11,000 screens.

Why the opportunity?

AMC’s stock dropped sharply in 2017 on concerns that we believe will prove transitory. It started falling in the Spring on fear that its controlling shareholder, the Chinese conglomerate Wanda Group, might have to sell its 58% stake in AMC due to the deleveraging being forced upon many Chinese oligarchs by the state. That has not happened yet, but the sale of a controlling stake would not likely occur at a fire sale price if it were to happen, and could, in fact, yield a satisfying price, and force the markets to more accurately assess fair value.

Another concern that weighed on the stock price in 2017 was the weakness in U.S. box office results industry-wide, which declined 2.7% for the calendar year 2017, after two consecutive record years in 2015 and 2016. Meanwhile the UK had another record year at the box office in 2017, +3.6% (and they have Netflix over there, too, since 2012), and AMC is the #1 player in the European markets.

2017's headlines remind us most of what happened in 2011. It was a very poor Q1 2011 at the box office (-20%), followed by a weak summer box office. A supposedly very scary trend had emerged with many calling for the pending doom of the theaters, a fear which helped push down our CKEC stock to less than $5 per share in late 2011 (from a high of $19 in 2010), Regal (RGC) dropped from $15 to under $10 during same period (AMC not public yet back then). From The New York Times on 9.14.11. Adding to our temporary misery at the time, in August 2011, Murray Stahl of Horizon Kinetics was interviewed by Barron's and his one short recommendation in that interview, of all the companies he could have discussed, was Carmike. He said that margins were razor thin and that profitability would erode within the next two years. Meanwhile, five years later, 2016 box office hit all-time high for 4th time in 5 years and Carmike was bought out at $34.35.

Theater attendance has indeed trended down over the last 15 years, dropping about 1.3% per year on average since then, but with ticket pricing up 2.9% per year on average over the same time frame, the box office revenue grew at a 1.6% CAGR over that period and the US hit a new all-time high as recently as 2016, before dropping 2.7% in 2017. We believe that as long aspeople like to leave home occasionally for entertainment purposes, the movies will remain a popular choice.

And while most of the industry headlines highlight the dip in movie attendance, and the sell side seems to react violently to weekly box office trends, it’s rare to see much written about the roughly $5.6B in annual concessions (food & beverage) sales at the theaters, which is a 85% to 88% gross margin business, versus 45% gross margins on ticket sales. Concessions are growing as a percentage of total revenues, and EBITDA margins thus generally creeping higher. Concessions are growing not just from price increases, but a broader selection, including real food, wine and beer in an increasing number of locations. This is a big deal. If concessions continue to grow as percentage of total sales, in 5 years they could be 40% of total sales (from 33% today) and this business goes from an 18% EBITDA margin to 22%+ easily.

Also, AMC (and even more so CKEC), historically over-indexed (out-performed) the industry on both attendance performance and concession sales per capita. In 2015, industry-wide attendance was +4.1%, but AMC was +5.2% and Carmike was +10%. And despite an overall attendance drop industry-wide of 2% over the 4-years ended 2015, AMC grew attendance by 1.6% during that time. For AMC the conversion to recliner seats produced immediate, significant increases in attendance, and it still does, albeit with a diminished magnitude in the US as much of the low hanging fruit there, in terms of the most productive locations to renovate, has been worked through. But not so in Europe, where AMC is just now beginning the process of implementing these renovations to the Odeon-UCI theaters they bought. EBITDA from those UK/European theaters will likely double over the next 5 years as the run-down, dilapidated theaters in generally good locations are refurbished with the reserved, recliner seats and better food options.

To preempt any questions on the impact of MoviePass, our two cents on it is as follows: if MoviePass benefits the theaters (saya 17% EBITDA margin becomes 18% for example, and sales go up unusually) it will show up as such and the sustainability of that incremental profit should be heavily discounted by the market as highly likely to be a one-off, non-recurring benefit. The stock shouldn’t rise much on the benefit of MoviePass, and thus not fall much when it ceases, which we believe it eventually will. AMC likely made a mistake in not getting in front of this, and should probably have made a subscription option one of their newly established pricing department’s first initiatives over a year ago. But Odeon (which AMC now owns) has already been doing it for a while in the UK and Europe, and it works well. Cinemark is now doing it as well. AMC just needs to catch up and present a subscription option at a sustainable price point and watch MoviePass fade into oblivion. It’s strange that AMC didn’t take the initiative on this years ago as they’ve experimented with it years ago and they see it works in Europe. Now they have to fend off an interloper and deal with disillusioned customers, who will likely find their MoviePass memberships frozen when they run out of money.

Finally, the 2nd largest U.S. theater chain, Regal (RGC), in December 2017 agreed to sell itself to a smaller UK company for $23 per share, a 53% premium to its November 2017 low of about $15, and a 9x EBITDA multiple. AMC at that same 9x EBITDA valuation would be $26.35, but we’re using a target multiple of 9.5x because AMC is much further along in the cap-ex intensive process of converting theaters to the new, attendance-boosting recliner seats, and AMC gets 20% of sales from Europe, where attendance trends have been stronger than in the U.S. and growth potential and valuations for theater stocks over there are generally much higher. So much so that AMC is now planning an IPO in London for its UK, Europe, and Nordic region theaters to both deleverage and attempt to capture some of that valuation premium.

AMC sold non-core investments in part to fund a $100M share buy-back program, and the CEO has bought shares personally at $31.50 (31,747 on 2/13/17), $24.72 (10,000 on 6/2/17) and $15.79 (35,000 on 9/14/17) which while not a huge amount ($1.8M in total) to invest for a guy who made $12.4M in total compensation in 2016, it is still a decent investment and an encouraging sign of confidence to other AMC shareholders, and something that we would like to see more of from some of the CEOs and directors at our other portfolio-held companies. Legendary value investor Seth Klarman (Baupost Group) bought 3.6M shares of AMC in Q3 2017, for a 6.7% stake in those class A shares (Q4 activity not out yet), so for once we’re not completely alone in our contrarian stance on this one.

Given all of the above, coupled with a 20% FCF yield and a sustainable 6% dividend yield, we believe AMC is one of the most attractive opportunities in the market today.

We are long AMC and may buy or sell additional shares at any time. This is not a recommendation to buy or sell securities. Please conduct your own research and reach your own conclusion.

We do not hold a position with the issuer such as employment, directorship, or consultancy.

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

Catalyst

We don’t require catalysts for investment, as we’re guided by valuation, but there are several of note for AMC:

Recliner seats, better food, being able to reserve a seat online or via one’s phone…these are major improvements to the movie going experience and they have notreached even half of the AMC locations in the US yet and they have barely scratched the surface in Europe yet with these renovations.
AMC’s loyalty program (“AMC Stubs”) has increased from 2.5M members to over 10M in less than 2 years.
Planned IPO in London for its UK, Europe, and Nordic region theaters.
Short interest is significant at 18 million shares (34.4% of the float) as of 1/31/18.

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			2018	2019
Price:	13.75	EPS	0	0
Shares Out. (in M):	129,012	P/E	0	0
Market Cap (in $M):	1,774	P/FCF	0	0
Net Debt (in $M):	4,700	EBIT	0	0
TEV (in $M):	6,474	TEV/EBIT	0	0