Description

This write-up is brief, but I wanted to get the idea up given the timeliness of the opportunity.  NCMI recently announced the acquisition of the #2 player in cinema advertising, bringing NCMI’s reach to 90% of the US cinema industry.  This deal will be transformational in a number of respects and ~20% accretive to FCF per share at the low end of mgmt’s guidance, yet the market has essentially ignored this accretion and is completely misunderstanding softness implied by 2Q guidance. 

SMOKING GUN: NCMI is down ~25% YTD and was off ~4% after 1Q earnings – investors think the business is broken and that disruptive digital ad technology is stealing spend from cinema, pointing to recent topline weakness at NCMI.  But the below data proves that cinema is alive and well!  The market has totally missed this, despite the data being available in public filings by CKEC and NCMI.  CKEC, having an ownership interest in Screenvision, reports Screenvision’s revenue each quarter in CKEC’s 10Q.  When you line up Screenvision’s revenue with NCMI’s advertising revenue, it is clear that recent weakness at NCMI has been the result of share losses.  What’s more, with the two companies together comprising 90% of the cinema ad market, their combined revenue illustrates that the ad medium is not declining – but rather is experiencing strong growth.  This dislocation presents an opportunity to go long NCMI with upside to $20/share (+30%), while clipping a ~6% dividend yield (closer to ~7% PF for the transaction).

SCREENVISION MERGER:  After the close on 5/5, NCMI announced the acquisition of Screenvision in a cash ($225mm) and stock ($150mm) deal valuing it at $375mm (~6x PF EBITDA).  Screenvision’s prior owners were Carmike (CKEC) and PE funds lead by Shamrock.  The deal is massively accretive to NCMI trading at ~12x EBITDA, and will increase FCF per share by ~20% at the low end of mgmt’s guidance.  Importantly, mgmt’s synergy guidance of $30mm is conservative, as mgmt sees upside to $40mm, and this excludes substantial revenue synergies.  The deal gives NCMI increased reach and scale, which are key factors to the attractiveness of an ad network.  This scale will give them access to new advertiser categories and contribute to a stronger pitch for the cinema medium.  In addition, the combined resources of NCMI and Screenvision will drive stronger, more consistent top-line growth than they could separately. 

BUSINESS OVERVIEW:  PF for the Screenvision merger, NCMI will control 90% of the cinema advertising niche market, which represents <0.5% of the total ad market and ~1% of the video ad market.  Cinema advertising, which is a mature and widely utilized medium in Australia and Europe, is still in its relative infancy in the US.  The three US largest exhibitors (RGC/AMC/CNK – collectively, the “Founding Members”) formed NCMI by combining their respective theatre circuits into one company and taking it public in 2007.  Since then, NCMI has grown its business of selling pre-show advertising to national (~75%) and local/regional (~25%) advertisers.  Cinema’s appeal draws from its (i) exceptionally high recall, (ii) ability to target specific demo’s, especially young audiences, and (iii) highly measurable and stable impression base.  It also benefits from its large-screen sight/sound/motion format, while being essentially the only video ad medium that does not allow skipping (e.g., DVR).  NCMI is poised to take share from network TV, as broadcast ratings continue to decline and skipping technologies become more prolific.  It's largely fixed cost structure will allow NCMI to leverage future revenue growth, driving accelerating FCF growth.  For more on the business and cinema advertising generally, please see NCMI’s investor presentation here: <http://investor.ncm.com/events.cfm>

VALUATION:  NCMI trades at a premium EBITDA multiple (historically ~12-13x / currently ~11x), but it’s important to recognize a few key factors: (i) the stock has historically traded on its dividend yield, (ii) the business generates very high EBITDA margins (~50%), very low capex, and strong CF-conversion, and (iii) NCMI is the dominant player in its niche marketplace.  To justify using dividend yield as the primary valuation metric for NCMI, it is important to understand its unique structure: 

PF for Screenvision, NCM LLC (the opco, “NCM”) will be ~50% owned by NCMI (the Holdco), where the public float is, and ~50% by the Founding Members (RGC/AMC/CNK).  When NCM was formed, it was structured to require that 100% of excess cash flow be distributed ratably from NCM to NCMI and the Founding Members.  As NCMI is just a holding company, with no operations, its sole use for the FCF received from NCM is to dividend it out to the public float.  As a result of the dividend payout ratio being <100% throughout much of NCMI’s history, a cash balance has accumulated there.  This cash cannot be accessed by the Founding Members and is the asset of the public float.  It serves as a buffer to protect the dividend, and can be tapped to issue special dividends as it grows.  In March, NCMI paid a special dividend of 50c per share from this cash at Holdco, and cash remaining at Holdco was $77mm as of March month-end.  This remaining balance could fund several quarters of dividends at the current level, even excluding any future cash distributed to NCMI from the NCM.  So, NCMI has a rock-solid dividend, and the company’s structure ensures that all FCF will be returned to shareholders through recurring and special dividends.  Since 2011, NCMI has traded at dividend yield averaging 5-6%, while briefly dropping below 4.5% in early-2011 and late-2013 and briefly hitting 7% in the 2H’11 market sell-off.  Typically, a yield wide of 5.5% has been the result of macro or secular concerns from the market.  I believe a 5% yield on NCMI’s PF dividend is appropriate given NCMI’s growth prospects and revenue synergies to be realized in coming years, combined with the CKEC disclosure that proves the market for cinema advertising is experiencing strong high-SD % growth.    

PF FINANCIALS:  In February, mgmt provided FY guidance for OIBDA for $222-232mm.  On the 1Q call, mgmt suspended FY guidance, but made the following statement in Q&A: 

Q - [Analyst]: … The second quarter number down so much, would this second quarter have been consistent with the guidance which is now removed, but when you gave the guidance, were you contemplating second quarter down as much?

A - Kurt C. Hall: Yeah, we were. One of the things that we looked at when we gave our annual guidance was the softer first and second quarters. So yeah, I guess the short answer is yes. Now I want to put a little thing in perspective. Last year's Q2 was the best Q2 we've ever had in our history. And in fact, I think it was up 14% or 17% from the previous year 2012. And just to put that in perspective, there's $122 million, $123 million of revenue last year, and some of that was Fathom obviously and $110 million the year before that and $100 million in 2010. So we're kind of in the range of the last three or four years, except last year happened to be a really, really good year. And then as you know, we had a little bit of a soft third quarter last year. So it was taken into account when we gave our guidance at the beginning of the year.

Using the low end of management’s EBITDA guidance and PF for Screenvision cost synergies (excludes revenue synergies), the below illustrates the stock’s fair value of $20/share (+30%):

CONCLUSION:  The market’s misunderstanding of competitive dynamics in the cinema advertising space has led it to underestimate NCMI’s PF earnings potential and meaningful undervalue the stock.  NCMI provides the opportunity to earn a ~30% return over 12-18 months through earnings growth and multiple expansion, while also clipping a ~6% dividend yield that is rock-solid.    

DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.   

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