|Shares Out. (in M):||8||P/E||0.0x||0.0x|
|Market Cap (in $M):||38||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||4||EBIT||0||0|
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Only $130k of stock typically trades per day but there is multi-bagger potential here so in addition to personal accounts, it could also be appropriate for small funds as I believe the upside potential justifies the mindshare.
DCIN reports on a June 30th FY and at around $5/share the stock is trading for 18x FY2014 consensus EBITDA but sub 5x FY2015 consensus EBITDA. I think they can earn over $20mm in EBITDA by June 30, 2016 so if you are willing to look a few years out, the multiple is 3x or less and a target price approaching $15 or more isn’t crazy. I realize these numbers suggest massive growth and I’d agree expecting outlier returns is usually reckless, but I hope to show these numbers aren’t unreasonable.
Misleading First Impressions
Let’s start with the bad. First, this is a roll-up strategy. I don’t typically find roll-up’s particularly appealing strategies for value creation but I think with a little work you will see management is exploiting an inefficient market and has an intelligent strategy to increase theater level returns post-acquisition and effectively reduce the deal multiples from 4-5x theater level cash flow (TLCF) to well below that. To-date the average acquisition price has been about 4.2x TLCF and successful execution of their strategy could ultimately lead to returns 2-3 years out that imply they are effectively paying multiples as low as 2-3x TLCF.
Second, the strategy requires capital and they need more powder. They completed a $5.7 mm equity raise in October and additional dilution is possible. On the last call management explained they are targeting a debt/equity ratio of one-to-one and are currently in talks with regional banks. Their goal is to support their growth by borrowing until they can use cash flow but additional dilution is a risk and they have a shelf outstanding.
Third, this is illiquid and as an exhibitor of motion pictures their success largely depends on the number of seasonal box office hits. A run of weak movies coupled with a deteriorating macro picture could pressure ticket sales.
Fourth, the CEO controls 60% of the vote through sole ownership of Class B shares which carry ten votes per share.
To review, I’m pitching a roll-up story where the company is controlled by the CEO, is an illiquid microcap, has substantial capital needs, and operates in an industry where they arguably don’t control their own destiny. “Yuck” feels like the appropriate response, but I think these are some of the reasons the opportunity exists.
DCIN was founded in July 2010 by a team of industry veterans and went public in April 2012 at $6.10/share, about a buck above the current price. Management is led by 72 year old CEO, Bud Mayo, the former founder of Cinedigm Digital Cinema Corp (Nasdaq:CIDM) and Clearview Cinemas before that.
Bud worked at IBM, went to Wall Street, and eventually founded Clearview (a theater circuit in metro NY area) in 1994 and made his investors a nice chunk of money after he IPO’d it in 1997 at $8 and sold to Cablevision for $24 one year later in 1998. Recognizing a shift to the digital format was inevitable, he founded Cinedigm in 2000. CIDM was set up to sell the technological solutions industry participants needed to transition from film to digital and the company provided financing and a platform of hardware, software and content choices movie theaters required to make the transition.
Bud’s extensive industry experience (he was inducted into the film exhibition Hall of Fame in 2010) allowed him to develop a deep rolodex of contacts and relationships with exhibitors across the country and as the transition to digital began to ramp in 2005, it became clear a number of mom & pop exhibitors were going to be left behind. This would create an opportunity for those with capital and a willingness and ability to profitability play what Bud calls the “small ball” M&A required to roll them up and profit from private/public multiple arbitrage.
The opportunity was no doubt appealing to Bud because in 2010 he “retired” from CIDM and within a year he had founded DCIN. Fast forward to today and the company has over 200 screens, is targeting 1,000 screens in 75 of the top 100 designated market areas, and has paid an average of 4.2x TLCF per acquired theater. This is despite the public theater chains historically trading for around 9x EBITDA.
Why The Opportunity Exists & How DCIN is Exploiting It
Over the past seven years there has been a disruptive technological shift from analog film to digital. Shipping film reels was expensive, time consuming, and inefficient. Digital provides many benefits to the movie houses and it also provides many benefits to the exhibitors but the problem exhibitors face is the equipment to run digital is expensive. Moving to digital on one screen can cost between $50 and $100k and when you are operating a small 6-8 screen theater with TLCF per screen of sub $100k, a cost of $300-800k to upgrade your system doesn’t put a smile on your face.
But, if you can afford it, the transition comes with numerous benefits. Among other things these benefits include the potential for substantial cost savings, 3D capabilities, an ability to easily screen alternative content like sporting events and concert footage, both live and pre-recorded, and the ability to easily move content between auditoriums. Most importantly, the increased ease of internal content distribution creates a more efficient system of screening and optimizes returns because it makes it easier to respond to demand and offer alternative programming during off-peak hours.
With small operators facing prohibitive upfront costs, financing arrangements were developed. Movie studios began paying exhibition houses for each movie shown on approved digital equipment and these payments, known as virtual print fees, or VPF’s, got the ball rolling on the transition from analog to digital. VPFs are structured to be paid for 10 years or until the cost of the digital equipment has been recouped by the exhibitor but the program was only designed to kickstart the transition from film to digital and it expired on 12/31/12. This means exhibition houses who didn’t convert to digital prior to 12/31/12 aren’t eligible to receive VPFs. Today, a majority of screens are digital and the major studios have said that come the end of 2013, they will no longer be making film prints for many movies.
The result of all of this is there are a large number of theater operators who are in a tough spot. They can either pay multiples of their TLCF to upgrade to digital, which will sting because they could have done this a year ago and it would have been subsidized, or they can sell to a larger player. Last year, The National Association of Theater Owners (NATO) estimated 20% of theaters would be unable or unwilling to upgrade and would probably close, and this is where DCIN comes in.
Exploiting the Opportunity
DCIN’s strategy is to purchase theaters at 4-6x TLCF, convert them to digital and/or upgrade the systems (audio, software, etc.), add 3D when appropriate, and then layer on alternative content which boosts revenue up to 10x when compared to the lowest grossing movie for off-peak timeslots (i.e. morning and mid-day, Monday through Thursday timeslots).
So far, a little less than 40% of the theaters they have acquired have required digital upgrades and they’ve found the simple act of converting to digital can significantly improve TLCF. For example, after converting their first three theaters, pro-forma TLCF increased 97% yoy at the targeted theaters, essentially halving the deal multiples they paid, (so if they paid 4x TLCF, the conversion alone took the effective multiples to nearly 2x).
The state of the industry is also conducive to a roll-up strategy because the industry is extremely fragmented. The top ten chains account for less than 60% of total screens. DCIN estimates there are about 40,000 screens in the U.S. and about 1/3rd of that total, or 13-14k screens, includes possible targets for consolidation. Many of these are mom & pop operators too small to attract attention from big players and of the 13-14k screens DCIN estimates are ripe for consolidation, DCIN is only seeking to acquire 800 (recall they have about 200 screens and their goal is to reach 1,000 screens).
Eight hundred screens corresponds to merely 6% of the market DCIN estimates is available for consolidation so I don’t consider this a herculean task and their growth to-date suggests they are perfectly capable of continuing to execute their strategy. Also, Bud explained in a July 2013 interview (link at the end), “the pipeline is very robust and exceeds 600 screens and we are actively negotiating for at least 250 of these.”
In a nutshell, the industry’s transition to digital created an opportunity for DCIN to scoop up mom & pops on the cheap. DCIN upgrades them and the effective multiple, already a low 4-5x TLCF, declines rapidly. I think this alone makes the story fairly compelling but this leaves out the opportunity associated with intelligently introducing alternative content.
Opportunity from Alternative Content
Despite the significant inefficiencies, the traditional theater operating strategy has been to play the same movies throughout the entire day. DCINs management estimates this approach results in seating only 10-15% of capacity and less than 5% of overall capacity Monday through Thursday. With 100% of the footprint digital, DCIN has adopted a strategy of offering alternative content in place of the lowest grossing films in off-peak hours and has realized revenue 10x what they were earning from the substituted film. This multiple of the revenue earned from alternative programming compared to the lowest grossing film the programming replaced has jumped around from quarter to quarter – last quarter it was 8.7x – but the strategy works and obviously makes a lot of sense.
The alternative content strategy is an evolution of the historical theater model wherein DCIN drives traffic on low-volume weekdays by featuring content like rock concerts, live opera, sporting events, fashion shows, religious services, auctions, documentaries, etc. Some of the content is exclusive and all of it commands higher ticket prices (typically 50-100% higher). Importantly, much of the alternative content isn’t one-off. Bud gives the example of Opera which has a full season but this could be extended to religious services, fashion shows, etc. Once they know the audience is there, they can capitalize by bringing the audience more content they are interested in and even doing live Q&As with the audience (they’ve had cast members of certain films do Q&A with audiences). The bottom-line is the strategy increases volume when they otherwise would have served a limited number of patrons.
“We are redefining what it means to go to a movie theater. It’s a very dynamic model that is beyond the conception of what anyone else is doing. We look at a movie theater chain very differently. You have to flip it over and think of it as a platform of a media company that is acquiring content after it’s produced and helping to distribute it and making sure it gets to the audience most interested in it.”
- Bud Mayo. July, 2013.
DCIN obtains alternative content through a number of sources but through one source, a JV with Nehst Studios, DCIN retains a stake in downstream revenue associated with the content (i.e. DVD sales, digital downloads, etc.). This is a small piece of the business but it has great potential to become a high-margin revenue stream and in August 2013 DCIN formed a distribution alliance with Screenvision under which Screenvision can present the content to members of their 14,000 plus screen footprint across the U.S. This should increase exposure to their content and has the potential to increase downstream revenue.
I think the earnings opportunity from this strategy is significant but it is still in early innings. About 3% of DCIN’s box office was from alternative content as of the fiscal year end and as of September about 6% of was from alternative content. Their target is to reach 20% and this is high margin business that promotes the theater as a destination event center for entertainment beyond the traditional fare of feature films.
Before diving into the valuation, I think a few items deserve consideration. One item of note is DCIN is collecting a notable stream of VPF’s as a result of many theaters in their portfolio having converted to digital prior to 12/31/12. This has reduced their film rent expense (largest line item expense) and upon reaching scale it should lead to higher margins relative to their peers. As of fiscal year end, DCINs film rent expense was about 50% of admissions revenue and this compares to 53-54% for peers. For this reason and others, I think a reasonable case could be made that DCIN deserves a premium multiple relative to the peer group. Not only will DCIN have higher margins than their peers upon reaching maturity but their potential to grow is much more attractive and unlike their peers, DCIN will receive additional revenue from the sale of content downstream (benefit of JV with Nehst), content they are promoting in their theaters.
Under existing agreements they should have about 224 screens by April of 2014 and management has reiterated they expect many more deals to be announced by the end of the current calendar year. In the past six quarters they’ve added nearly 200 screens to their count so I estimate they will reach 400 screens by June 30, 2015, or 176 screens over a little more than six quarters.
Capital Need - Cost per screen
I estimate DCIN has been paying around $200k per screen so far. Assuming $200k/screen implies they will need about $35mm in capital to acquire 176 additional screens.
With the October equity raise, DCIN has about $7mm in cash and $10mm remaining in a JV agreement set up with Start Media to acquire additional theaters. On the last call management explained a target debt/equity ratio of 1/1 which implies they are hoping to raise another $22mm or so in debt (and they explained on the call they are already in discussions with regional banks). Together this is about $39mm in capital vs. their $35mm need, so I think they can reach 400 screens without diluting equity holders.
Enterprise Value with $22mm Capital Raise
The market cap is about $38mm, they have about $1.3mm in cash plus another $5.2mm from the equity raise (post fees), $10.5mm in debt, $9.2mm in a non-controlling interest, and I expect they will raise an additional $22.3mm of debt to reach 400 theaters. This amounts to an EV estimate of $73.6mm.
My 400 screen EBITDA estimate is $15mm and this assumes a margin of 16% on revenue of $94mm. I believe this is conservative as earnings power will likely be higher but here is how I get there…
First, my revenue build assumes 20,000 patrons per screen vs. Reading, Carmike, Regal, and Cinemark who capture 22,000 - 50,000 patrons per screen on average. So I’m assuming DCIN will operate either the smallest auditoriums in the country or have much lower attendance per screen.
Second, I assume admissions per patron and concessions per patron of roughly $8.30 and $3.50, respectively. This represents growth of only 3% per year despite the fact that DCIN will be layering on higher priced alternative content. I’d also point out that since 2006 the CAGR of nationwide ticket prices has been 3.3%, so I think 3% is a reasonable assumption.
Third, peer group EBITDA margins range between 15-21% vs. my assumption of 16%. I think my 16% assumption is conservative because due to VPFs, the contribution from alternative content, and high-margin revenue from the sale of content downstream, DCIN should earn higher margins than their peers upon reaching scale. Looking at EBITDA another way, the peer group earns $40 - $100k (average of $72k) in EBITDA per screen on average vs. my estimate of $33k/per screen for DCIN.
400 Screen EV/EBITDA
400 screen EBITDA potential of $15mm implies a multiple of 4.9x against a $74mm EV estimate. This compares to peers who have historically traded around 9x yet have only expanded revenue at mid-to-high single digit growth rates at best. At 9x $15mm in EBITDA, DCIN would trade for $13 per share. (They also have an NOL but I estimate it’s worth maybe $0.20 cents, so it’s not meaningful to the valuation).
DCIN’s goal is to reach 1,000 screens and I think they can reach over $20mm in EBITDA a few years out which makes this a very cheap stock (Capital IQ reports FY June 30, 2016 consensus EBITDA of $24mm). Bud would seem to agree as he owns about $4mm worth of stock, or 11% of the company, and has a 10b5-1 in place to automatically buy the common on a bi-monthly basis.
Considering the growth potential, I think a $10 target is perfectly reasonable and a stock in the teens isn’t unlikely a few years out. At maturity, DCIN should have industry leading margins and tremendous local brand value, a result of DCIN potentially redefining the entertainment role of the local theater.
Bud retired once already and at 72 years old I think it’s reasonable to believe he does so again in the not so distant future. As the controlling shareholder, I’d bet he liquidates his stake by selling DCIN to one of the larger industry players. Until then, I’m happy to own his stock while he keeps rolling up mom & pop operators for low single digit multiples of theater level cash flow.
Some links to interviews with Bud and some articles on Bud and DCIN follow but first, a review of the elevator pitch…
- Microcap movie theater exhibitor rolling up mom & pop operators at low single digit multiples of cash flow and exploiting public/private multiple arbitrage opportunity. These operators are too small to attract the attention of big industry players because acquiring them doesn’t move the needle for the larger operators.
- Post-acquisition, DCIN layers on alternative content that boosts revenue to levels up to 10x what they would have collected from the lowest grossing films the alternative content replaced.
- DCIN uses it’s footprint to promote alternative content it has rights to downstream and this coupled with ownership of VPFs creates a higher margin operation vs. peers.
- CEO is an industry expert who sold his last theater chain and at 72 is likely to do it again upon achieving scale.
DISCLAIMER: This write-up is not an offer to provide investment advice or a solicitation of such an offer. No one should rely on the information contained in this write-up to make any investment decision. The write-up contains and is based upon information the author believes to be correct but may be inaccurate. The author assumes no liability if such information is incorrect. The author has no duty to correct or update the information contained herein. The author may buy, sell or sell short the security at any time without notice. This document contains forward-looking statements based on the author’s expectations and projections. Those statements are sometimes indicated by words such as “expects”, “believes”, “will” and similar expressions. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.
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